Taxing Pricey Insurance: No Health-Care Cure

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As congressional lawmakers scramble to find ways to pay for health-reform legislation that could cost upwards of $1 trillion over the next decade, there is probably no funding method more unpopular with the American public than taxing health benefits. Employers have been providing tax-free insurance to workers since World War II, when federally mandated wage freezes led to a bonanza in this form of nonsalary compensation.

About two-thirds of nonelderly Americans get health insurance through their employers, and despite the fact that the tax break is regressive — the more expensive your employer's health-insurance plan, the bigger the break you get — very few of them would look kindly on reforming the system. With that in mind, some lawmakers have proposed capping the amount of employer-sponsored health insurance that could be provided tax-free — leaving only workers with pricey, so-called Cadillac health plans worth north of $25,000 a year subject to new taxation. But even this isn't exactly guaranteed to have popular support.

Now, taxing insurance companies? That's a little easier to sell to voters, which helps explain why the powerful Senate Finance Committee has reportedly pivoted from taxing workers to embracing a plan to tax the insurers who offer the most expensive health-insurance plans. Doing so would generate some tax revenue — though far less than the $1 trillion–plus over 10 years that could be generated by eliminating the tax-benefit break entirely — and possibly help "bend the curve" (to borrow the wonky slogan du jour) of rising health-care costs. The theory is that high-end insurance that covers everything at little or no cost to consumers discourages those people from shopping around for less expensive care and encourages wasteful overuse of the health-care system.

The idea for an excise tax on insurers was put forth by Finance Committee member Senator John Kerry and modeled on a similar 1994 proposal from Senator Bill Bradley. President Obama has said as recently as July 22 that he's open to capping the tax benefit on health plans in some form.

It may seem like a neat solution to a thorny political problem, but as with every aspect of health reform, it's not nearly that simple. For starters, most large companies (1,000 employees or more) are self-insured, with a private health-insurance company merely acting as the benefits administrator. In these cases, Kerry's proposal would levy the excise tax directly on employers, whose extra cost burden could be (and many say most certainly would be) passed onto employees in the form of higher contributions to premiums, higher deductibles and higher co-pays. "It is not a tax on insurers," says James Klein, president of the American Benefits Council, which advocates for employer-provided benefits. "It is a tax on employers and, therefore, workers."

Moreover, the term Cadillac health plan is a tad misleading. Aside from a small number of corporate executives — like the CEO of Goldman Sachs who reportedly enjoys a health plan costing $40,543 a year — many of the Americans with health-insurance plans substantially above the national average (which is about $13,000 for a family of four) are state employees and union members. It's true that the few Wall Street and other Fortune 500 executives have gold-plated plans that pay for any doctor or specialist, require no out-of-pocket expenses and tack on perks like nutrition counseling. But the vast majority of Cadillac plans are those that typically offer consumers relatively low co-pays for doctor visits and generic and name-brand prescription drugs and preset and relatively affordable out-of-pocket costs for expenses like hospitalizations. Leaner plans, on the other hand, often charge consumers a percentage of total costs, known as "co-insurance," and also have high up-front deductibles.

"If people think these Cadillac plans are primarily covering wealthy executives, they are mistaken," says Tom Billet, a senior health-benefits consultant for Watson Wyatt, a corporate consulting firm. In reality, many more of the most expensive employer-based health-insurance plans cover people like the families of New Hampshire state employees who, according to the Boston Globe, have policies worth $20,400 per year. (The employee contribution is $60 per month.)

The Senate Finance Committee has not yet introduced draft legislation, so it's still unclear what level of Cadillac health benefits would be taxed under the Kerry proposal. But those familiar with the committee's discussions say the tax threshold could be based on either what federal-employee benefits cost or the average cost of insurance nationwide. Nearly 20% of Americans covered by employer-sponsored health insurance have policies costing more than 120% of the national average, according to the Kaiser Family Foundation.

Still, setting a national threshold may not make sense. Health-insurance costs, after all, vary widely depending on where you live. In regions where there is less competition among insurers or where health-care costs are relatively high (like much of the Northeast), insurance costs more. It's also more expensive to insure workers employed in high-risk fields like manufacturing.

Municipal unions, which in recent years have had more success winning premium health benefits than wage increases, are incensed at the notion that their members could get hit by a new health-insurance tax, even an indirect one. "In our judgment, we think it's inequitable to tax individuals because of who they work for, what they do or where they work," says Chuck Loveless, legislative director of the American Federation of State, County and Municipal Employees. Of the Kerry excise tax proposal, Loveless says, "We're looking at it very closely and we're trying to calculate the cost of excise tax on our plans, but I do know it's going to hit some union plans."

Despite whatever opposition new benefits-tax proposals might face, it's unlikely health-reform legislation will emerge without them. The Senate Finance Committee — one of five in Congress that oversee health care and the only one that has not yet unveiled at least draft legislation — must include in its draft a plan to pay for reform. The three Democrats (led by Finance chairman Max Baucus of Montana) and three Republicans (led by Chuck Grassley of Iowa) trying to hammer out a bipartisan agreement behind closed doors have made some progress on reaching a consensus. In addition to scrapping a requirement that employers provide workers with insurance, the senators are in favor of the excise tax and are reportedly targeting benefit packages that are worth more than $25,000 a year. As Len Nichols, director of the Health Policy Program at the nonpartisan New America Foundation, says, taxing employees "has been taken off the table in the Finance Committee, but it's still in the room because they haven't closed the [budget] gap yet."

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