As work on trying to overhaul the Affordable Care Act continues, lawmakers are considering a bold and what would likely be a controversial move to eliminate the tax exclusion for employer-sponsored health benefits.
The amount of taxes that are not collected as a result of the exclusion amounts to about $216 billion a year according to the Tax Policy Center, and is therefore a significant pool of untapped funds.
The current exclusion has its roots dating back to World War II when the government ordered that wages be frozen and tax-free health insurance be available. The notion of now taxing the benefit would likely not go down well with anyone who currently receives employer-sponsored health insurance.
While economists have long hated the tax exclusion, workers and employers love it. Depending on how much you pay in taxes, the savings on the cost of expensive health benefits can be substantial. Most Americans under 65 benefit from tax savings associated with this policy.
The outline details how funds raised through the collection of these taxes would be spent on various aspects of the health insurance system like Medicaid, tax benefits for health savings account enrollees, and a universal tax credit-based system that would help individuals buy insurance on the open market.
The House committees are also struggling to deal with the tax credits established by the ACA to help individuals buy coverage on government-operated health insurance exchanges, and how to eliminate that system.
In place of the ACA subsidies, the House bill starting in 2020 would give tax credits – based on age instead of on income. For a person under age 30, the credit would be $2,000. That amount would double for beneficiaries over the age of 60, under the proposal.
Republicans are considering various proposals for the tax exclusion:
- Cap the tax exclusion at a certain level, such as $10,000 in benefits.
- Eliminate the tax exclusion altogether.
- Phase out the exclusion over time.
The outline did not specifically state that any captured taxes would specifically be used to pay for tax credit, but analysts say that it would be funded this way.
Capped tax exclusion
If the capped method is implemented, it would likely set a maximum amount of benefits that would not be taxed – and any benefits over that amount would be taxed as salary.
Cap example
If Congress sets a cap of $8,000 for single coverage, a worker who receives $9,500 worth of health coverage paid for by his employer would not pay taxes on the first $8,000 in benefit. However, the remaining $1,500 would be treated as ordinary income and the full range of tax would be levied on the amount.
Both the employer and the employee would be exposed to the tax.
The danger is that the move could also spur states to adjust their laws to match federal law so that state income taxes are also captured on the benefit.
If talk of a cap sounds familiar, that’s because this is kind of how the ACA “Cadillac tax” was supposed to work. Under that measure, any health plan that is worth more than an established amount would be taxed at 40% for every dollar over the threshold.
The whole idea behind the Cadillac tax was that it would levy health plans that are deemed overly generous and hence do nothing to curtail the use of health services. But eliminating or capping the tax exemption would have no such effect, experts say.
We will keep you posted as the process develops.