Congressional Republicans are gearing up for a battle over tax reform. Nearly everyone in the caucus would like to slash corporate and individual taxes. But they will need to close some loopholes in the tax code if they hope to offset the revenue they will lose by lowering rates.
One of the sacred cows Republicans ought to target is the “employer exclusion,” which exempts employer-sponsored health benefits from income and payroll taxes. By effectively subsidizing health insurance, the exclusion has exacerbated our nation’s health cost crisis.
Taxing health benefits would make America’s health insurance market fairer and more economically efficient. The exclusion is a relic of the World War II era, when employers began offering workers generous health benefits to get around government wage and price controls.
Before then, most people did not receive health insurance through their jobs. The employer exclusion has since become the single largest break in the tax code. This year, the federal government will forego about $350 billion because of the exclusion.
Businesses understandably want to preserve this loophole, which helps them recruit and retain workers. Employees like the loophole as well. To them, a dollar of tax-free health benefits is worth more than a dollar of taxable income.The exclusion might be popular — but it is bad public policy.
First, it is deeply unfair to Americans whose employers do not offer health coverage. Many of these folks do not receive a subsidy to buy their own policies on the individual market.
Second, it distorts the labor market. Over 155 million people receive health insurance through their jobs. By tethering health insurance to employers, the government has made it less likely these folks will seek out new jobs or start their own businesses, since they would have to give up their health plans.
Third, it is highly regressive. In 2016, the top two-fifths of earners received nearly 70 percent of the benefit from the tax break. The bottom fifth of the income distribution, meanwhile, captured one-half of 1 percent of the exclusion’s benefits.
Worst of all, the loophole drives up health costs. When employers pick up most of the cost of coverage — “first dollar coverage” — people have less incentive to consume health care responsibly. This leads to wasteful spending that inflates insurance premiums.
The average employer contribution to a family insurance plan more than tripled percent between 1999 and 2016, rising from $4,247 to $12,865. The explosive growth in premiums has left businesses with less money for wages. Combined salaries, wages, and bonuses increased just 58 percent from 1999 to 2015.
In short, the federal government is sacrificing hundreds of billions of dollars a year to subsidize needlessly lavish health coverage for wealthy folks. It’s hard to imagine a loophole more deserving of the axe.
It would be politically impossible to do away with the loophole all at once. But Republicans could start the reform process by capping the exclusion at $8,000 for individual plans and $20,000 for family plans. These limits are slightly higher than the average premium for an employer-sponsored plan. So the majority of workers wouldn’t be affected.
To keep up with the gradual rise in healthcare costs over time, these caps could grow at the inflation rate plus 1 percent. Such a reform would not ban employers from offering extravagant health benefits. But it would stop subsidizing such decisions with taxpayer dollars.
Many employers would respond by sponsoring less comprehensive high-deductible plans, and pay workers higher wages instead. These high-deductible plans, especially if paired with tax-advantaged Health Savings Accounts, would encourage workers to shop around for health care. And that would put downward pressure on overall healthcare spending.
It’s time for Congress to restore some fairness and fiscal discipline to our health care sector by capping the employer exclusion. Lawmakers could use the tens of billions in new revenue to finance permanent tax cuts that boost economic growth, increase wages, and create jobs.