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Senator Kerry has floated the idea of a tax on high premiums as an alternative to caps on the exclusion for employer-sponsored health insurance (ESI). There are no public details, but press reports indicate bipartisan interest in the idea. The proposal would tax insurers and self-insured employer plans if the average premium “substantially” exceeded the highest premium on policies offered to federal employees under the Federal Employees Health Benefits Plan (FEHBP).
The proposal is reportedly modeled on one offered by Senators Bradley and Danforth during the last health reform effort in 1994. That proposal would have applied a 25% excise tax to premiums that exceeded a cap. (One blogger reports that the excise tax rate would be 35% applied to family premiums above $25,000—a very high-level—but Kerry isn't saying what the rate or the threshold would be.)
Like several commentators, my first reaction was negative. The subsidy for ESI is the exclusion from income and payroll taxes of health insurance premiums paid by employers. It's very large for higher income people—because they face higher marginal tax rates—and small for those with lower incomes. The ESI exclusion is thought to contribute to high health spending because it's an open-ended subsidy. The more generous your health insurance plan, the more you save in taxes. Capping or eliminating the exclusion would reduce or eliminate this incentive for overspending. It could also save the Treasury substantial revenue.
The premium tax, in contrast, is a flat rate. A 25% excise tax would likely be passed onto employees in the form of higher premiums. The excise tax will be greater than the tax savings from the ESI exclusion for low-income workers, and smaller than the value of the exclusion for those with high incomes. That is, it would be regressive.
However, the “right answer”—the cap on the ESI exclusion—seems dead in the water. It would violate President Obama’s pledge to spare all but the very rich from tax increases. Kerry’s proposal, in contrast, would nominally be paid by insurers. Economics 101 tells us that it doesn't matter whether the seller or buyer writes the check to the Treasury: the after-tax price facing seller and buyer is the same. But politically, having insurers “pay” the tax may avoid a major political problem.
How much should we worry about the regressivity of the proposal? The answer depends on some things that are hard to tell a priori. If the premium excise tax effectively discourages the purchase of costly insurance plans – so almost nobody pays it – then the regressivity is no big deal. Employers will spend less on health insurance premiums and employees’ wages will (eventually) rise. Income and payroll taxes will increase just as they would under an ESI cap.
If some employers continue to offer insurance with premiums that exceed the cap, then the actual distributional effects will depend on how the higher premium costs are distributed among workers. If everyone pays higher premiums, then the excise tax is indeed regressive, but it's likely that high wage workers pay more than their share of premiums in a firm, because insurance is worth more to them than it is to low-wage workers. In that case, the regressivity of the proposal might be partly or completely offset.
A more fundamental point is that this proposal makes sense only in the context of a reformed health insurance market. In the current market, small firms and those with older and sicker workers can face very high premiums even for very modest coverage. They could get hit by the premium excise tax with little recourse but to drop coverage altogether. However, if uninsured individuals and small employers can acquire decent insurance for premiums below the threshold for the excise tax, as they presumably could through the health insurance exchanges envisioned by reform proposals, then the tax could be easily avoided while retaining adequate coverage.
Senator Kerry, who was a junior member of the Senate Finance Committee in 1986, doubtless recalls that The Tax Reform Act of 1986 was accomplished in large part because most taxpayers didn’t understand that corporate taxes are ultimately passed on to people, through reduced asset returns or wages, or through higher product prices. That allowed for giant individual income tax cuts in a revenue-neutral tax bill. Kerry wants to repeat the trick—this time counting on the fact that most people won’t understand that higher premium taxes will at least partially be passed on to insurance policy holders.
It’s disturbing to base policy on economic illiteracy, but experience suggests that it just might work.
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