Replacing Cadillac tax with cap on exclusion may be more effective

The so-called “Cadillac tax” established by the Patient Protection and Affordable Care Act (ACA), which places an excise tax on high cost employer-sponsored health insurance plans, has been coming under scrutiny recently, and calls for its repeal have been increasing. An analysis issued by the Urban Institute and the Robert Wood Johnson Foundation suggests that replacing the controversial Cadillac tax with a cap on employer exclusion may be more effective because it has more certain distributional impacts. However, if an exclusion cap cannot be accomplished, the Cadillac tax must be retained for its revenue creation and cost containment.

Cadillac tax. The ACA established the Cadillac tax, which places an excise tax on certain high cost employer-sponsored health insurance plans. It is estimated that the tax will generate $87 billion in revenue from 2018 through 2025. In 2018, the tax will equal 40 percent of the value of health benefits that exceed $10,200 for individuals, and $27,500 for families. According to the report, the tax is expected to affect almost 26 percent of firms in 2018 and will impact more employers as health costs continue to increase.

Tax exclusion. Under the current tax exclusion law, employers can provide a portion of workers’ compensation tax free because employer contributions to health insurance are excluded from income and payroll taxes. The exclusion is the largest federal tax expenditure, costing over $250 billion in income and payroll taxes in 2015. Additionally, projections have it costing $3.2 trillion from 2016 through 2025. The study notes that some have argued that the employer exclusion disproportionately favors high-income workers because their tax savings are greater than lower-income workers who receive little or no benefit. Additionally, some have argued that the exclusion encourages individuals to over-insure and overuse health services, which contributes to ballooning health care expenditures.

Distributional effects. The study compared the distributional implications of the Cadillac tax with the impact of limiting the tax exclusion. They found that the tax and the exclusion cap would raise the same amount of revenue and had generally the same distributional effects, with the exclusion limit being “somewhat superior.” The study noted that the distributional effects were similar only in instances where employers lowered benefits to avoid the Cadillac tax, which most firms are expected to do. Therefore, when examining the two options, if possible, replacing the Cadillac tax with a cap on exclusion would be preferable because it would have more certain distributional effects. However, if such a replacement is not possible, the Cadillac tax must be retained to ensure the financial stability of the ACA because it is a significant source of revenue and cost containment.

SOURCE: http://www.urban.org

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