Congress Should Do More Than Repeal the 'Cadillac' Tax

Despite the bitter divide between Republicans and Democrats over the Affordable Care Act (ACA), they seem united on one issue: the Cadillac tax should be repealed. Starting in 2018, a 40 percent excise tax will be imposed on high-cost employer health plans (so-called Cadillac plans). The tax will come out of every dollar above $10,200 a year for individuals and $27,500 a year for families. Such a large tax will force unpopular changes in health insurance used by millions of workers and their families.

Employer-sponsored health insurance has long received a special tax break. Employer and employee contributions are excluded, without limit, from both income and payroll taxes. The savings amount to about 30 percent for the average worker. While this tax exclusion has made workplace health insurance affordable, it has also fueled the rapid growth of health spending. More spending has encouraged tremendous advances in health care, but it has also led to the wasteful and sometimes harmful use of medical services.

For that reason, I along with 100 other health economists and policy experts signed a letter to Congress urging them to avoid repealing the Cadillac tax unless they have an alternative tax change that would more effectively curtail cost growth. None of us are particularly in love with the Cadillac tax, but we are concerned that politics could drive out a provision that, despite its warts, discourages wasteful health spending.

An imperfect but useful measure

Widespread opposition to the Cadillac tax is not surprising. The current unlimited tax exclusion saves workers some $250 billion a year, according to the Congressional Budget Office. The Cadillac tax would reduce those savings, starting with the most expensive health plans offered by unions and large employers. Between 2018 and 2025, the Cadillac tax is expected to produce $87 billion in new federal revenue-on average, about $10 billion a year, or 4 percent of the tax savings received by employer-sponsored plans.

Employers have already begun to adjust their benefit packages to avoid the tax. Benefits consulting firm Aon Hewitt found that 62 percent of firms surveyed last fall were making significant changes to their health plans for 2015. A third of those employers planned to reduce their health plan expenses through higher out-of-pocket costs for their employees. Narrower networks of physicians, hospitals, and services are also part of the strategy adopted by many firms.

Such actions reduce employee health benefits and increase what workers pay directly for their care, giving them more "skin in the game." These changes are not popular, but they promote prudent use of health services and start to bend the cost curve down.

The Cadillac tax is far from an ideal reform. Its major defects include:

* Workers are not in charge of their own health insurance under the Cadillac tax. Key decisions on which health plans are offered to workers are left in the hands of employers. Families who would have been willing to pay the tax if they could retain their current health plan will not have that opportunity.

* The Cadillac tax undercuts the use of health savings accounts (HSAs), which promote prudent purchasing of health care services. All contributions to HSAs count towards the threshold limits set by the law. Although these accounts are an increasingly popular way of financing health care costs, particularly in conjunction with high-deductible health plans, the prospect of having to give the government 40 cents out of every dollar could result in employers curtailing their contributions.

* Low-wage workers are disadvantaged by the Cadillac tax. Although most employers are likely to focus on trimming health benefits to avoid the tax, some firms may reduce hiring and limit wage increases to cover the extra cost resulting from the tax. This will mostly impact low-wage workers, who have fewer financial resources to fall back on than higher-paid workers.

* Workers living in high-cost areas such as New York City or San Francisco are disadvantaged by the Cadillac tax. The use of fixed-dollar limits fails to account for regional variations in health care costs.

* The Cadillac tax will eventually impact everyone with employer coverage. The thresholds used to determine whether a health plan is excessive ($10,200 for individuals and $27,500 for families in 2018) are indexed to general inflation. Because health care costs generally rise much faster than that, eventually all employer health plans will exceed what Obamacare considers acceptable levels of health care coverage.

What will Congress do?

In recent years, it has been a fairly safe bet that Congress would not be able to pass legislation addressing controversial issues. The Cadillac tax may be an exception, but there are good arguments on the side of inertia-which may well be the best outcome, at least for a few years.

Republicans have proposed various alternatives to the way the tax code treats health insurance: from caps on the amount that can be excluded from taxes, to replacing the exclusion with a refundable tax credit available to everyone who purchases health insurance. Although such ideas would eliminate the Cadillac tax and its problems, there is very little chance that they will be enacted by the current Congress.

House Republicans have included repeal of the Cadillac tax in the reconciliation bill now being debated, but there is no chance that the President will sign it into law. Any effort to repeal the tax through a stand-alone bill is also likely to fail as both political parties will find something they do not like.

Egged on by their labor union supporters, Democrats simply want to be rid of the tax. Republicans are less unanimous in their views. Some oppose modifying parts of the ACA as that slows progress on repealing the entire law. Others are willing to repeal the Cadillac tax but may not agree on how best to limit tax breaks for health insurance. If an agreement is reached, it will be seen as a tax increase even if the replacement results in less federal revenue than the Cadillac tax. Many Republicans will also have second thoughts about aligning themselves with Hillary Clinton on this issue. The result: gridlock.

There will probably be no action on the Cadillac tax until 2017. The next president will be more likely than Mr. Obama to accept significant changes in Obamacare, and political pressure to repeal the tax before it takes effect will be intense. Despite the temptation to take the easy way out, we must resist the urge to repeal the Cadillac tax unless we replace it with a more comprehensive policy that effectively curtails excessive growth of health spending in this country.