What Kind of Tax Reform Do We Need?
This is an introduction to a package of five articles offering opinions on what kind of tax reform would be best. Scroll down below the introduction to see the articles. There’s one thing about corporate tax reform that everyone agrees on: that we should have it. But what should it look like? On that point, opinions are scattered. It was not difficult for CFO to find strong opinions on this topic. We’ve gathered the perspectives of a CFO, a principal of a Big Four firm, a university pr ..
Philip G. Cohen
This is one of five articles offering opinions on what kind of tax reform would be best. See the others, below left.
As a former tax counsel to the Senate Finance Committee who helped develop provisions of the Affordable Care Act, I can say this unequivocally: the law’s so-called “Cadillac Tax” should be repealed.
It was bad tax policy then, and it remains bad tax policy now. If it remains in place, it will eventually undermine employer-based health insurance, as almost all companies will sooner or later become subject to it and as a result may be likely to drop employee health benefits.
Under our tax laws, employer and employee contributions for employer-sponsored insurance coverage are not considered taxable income to an employee. They are, in tax parlance, an “exclusion.”
For decades, economists have suggested that Congress should place a limitation on the exclusion. The drafters of the Affordable Care Act (ACA) did just that with the Cadillac Tax, which limits the exclusion by imposing an excise tax on employer-sponsored insurance coverage whose aggregate cost to employer and employee exceeds a specified threshold.
If the Cadillac Tax is repealed, I believe Congress and the next president (whichever party he or she belongs to) will still seek to limit the exclusion for employer-sponsored insurance.
Why? If the Democrats win the White House, they will need to replace the lost tax revenue to continue to pay for the ACA’s coverage expansion. If the Republicans win the White House, they will endeavor to reduce health-care spending by making individuals better “consumers” of health care. Limiting the exclusion would likely meet either policy goal.
When will the Cadillac Tax be replaced? Probably in 2017, when Congress and the next president presumably will tackle tax reform (note that even if a Republican wins the White House, tax reform may occur before an ACA replacement is enacted).
What will replace the Cadillac Tax? I believe Democrats and Republicans will reach a compromise with what policymakers call a “direct cap” on the exclusion (where amounts over the cap are taxable to the employee).
If policymakers pursue a direct cap, they must structure the limitation with precision (so as to address flaws of both the current exclusion and the Cadillac Tax).
The current exclusion is regressive. To address this flaw, the value of the tax benefit for mid- to upper-income employees could be limited to 25% or 28% of the cost of the insurance coverage that is under the cap. For employees in lower tax brackets, an additional “exemption for health insurance” — similar to the current “dependent exemption” — could be offered, which would further reduce a lower-income employee’s tax liability, if any.
The goal for limiting the exclusion is to reduce offers of “comprehensive” health coverage, like 100% pay-all plans and plans with low or no cost-sharing. Typically, the dollar value of a health plan (i.e., the aggregate cost to employer and employee) is a proxy for its “richness.” However, the dollar value for a comprehensive plan providing rich benefits in Arkansas may be the equal the same dollar value for a less comprehensive, high-deductible health plan (HDHP) in the Bay Area. To address this inequity, the dollar value of a direct cap must vary by geography.
Alternatively, limiting the exclusion could be based on the greater of a dollar value or the “actuarial value” (AV) of the plan. An AV metric (which is a measure of how much the insurance pays for medical expenses) would effectively impose a tax on the comprehensive plan in Arkansas, while shielding the HDHP in the Bay Area from any tax.
Policymakers often use the tax code to encourage behavior. If Congress and the next president want to continue to encourage employees to save their own money in a Flexible Spending Arrangement or a Health Savings Account to pay for out-of-pocket medical costs, employee contributions to these account-based plans must not be counted toward the limitation. In addition, Congress and the next president may want to encourage “value-based insurance designs” and wellness programs. Providing an exception for these types of coverage may accomplish this goal.
Finally, unlike the Cadillac Tax, a direct cap cannot be indexed to the Consumer Price Index. An equitable index rate is the rate of medical-cost inflation.
While the employer and labor community continue to raise concerns about any limitation on the exclusion, I believe some sort of limitation will remain in the law once the Cadillac Tax is repealed. If policymakers continue to pursue this policy, they must be precise in how the limitation is structured, and they must be mindful not to undermine the employer-based health system, which the Cadillac Tax will surely do.
Christopher Condeluci is principal and sole shareholder of CC Law & Policy and former tax counsel to the U.S. Senate Finance Committee. He can be reached at [email protected].