Strategic Communications and Marketing News Bureau

How taxes on health insurance benefits might affect you

A decades-old tax exemption on employer-provided health insurance is drawing attention as Congress tries to find money for an Obama administration push that would expand health care coverage to every American. Law professor Richard L. Kaplan, an expert on the U.S. tax code, examines the potential consequences in an interview with News Bureau Business & Law Editor Jan Dennis.

Why is Congress trying to change the tax treatment of employer-provided health insurance?

President Obama has indicated that health-care reform is his major domestic priority this year, and most of his proposals would increase government expenditures substantially. He has suggested various tax increases to pay for these proposals, but is especially interested in redirecting funds currently in the health-care system. A change in the tax treatment of employer-provided health insurance fits into this conception. And within that context, the current tax exclusion of such insurance is the single biggest source of funds that might be tapped.

Who would be affected by this change?

That depends on the scope of the changes enacted. Some policymakers want to put a dollar limit on the amount of health insurance premiums that can be excluded from taxation. That approach was actually part of the tax simplifications suggested by President George W. Bush’s 2005 tax-reform panel. Depending on the limit chosen, this change would affect only employees with especially costly health insurance plans. But other policymakers want to reduce the exclusion on a sliding scale based on an employee’s income from all sources, so-called “adjusted gross income.” That change would apply primarily to upper-income employees, at least initially. That is, once this sliding scale feature is in place, Congress could easily lower the thresholds to affect more employees. In fact, if revenue generation is the main concern, the limit might be set fairly low, thereby affecting a significant number of employees and their families.

Is anyone proposing to eliminate the tax exclusion entirely?

Yes. Health economists and some tax specialists have advocated eliminating this exclusion entirely for years. The previous administration took this very position, as did President Reagan two decades earlier. The idea is to put Americans on an even playing field in terms of securing health insurance, rather than favoring those persons whose employers arrange for their employees’ health insurance. The concern with the current tax exclusion is that people do not know the cost of their health insurance and tend to overuse health services. Eliminating the exclusion, some contend, would give employees more “skin in the game” and make them more sensitive to the cost of health care.

Why was the tax exclusion enacted in the first place?

Actually, the tax exclusion is a result of efforts during World War II to provide employees with additional compensation in the face of wartime wage controls that precluded increases in salaries. The tax exclusion evolved from this strategy without any real determination that it was appropriate. I examine this history and some of its impacts on employer-provided health insurance in my article, “Who’s Afraid of Personal Responsibility? Health Savings Accounts and the Future of American Health Care,” available here, specifically pages 537-548.

What would happen to health insurance if these changes were made?

No one knows for certain, and the results would likely be different depending upon the specific change enacted. For example, labor unions have negotiated very comprehensive health plans over the years, with low or no deductibles and very limited co-payment obligations. This strategy makes economic sense when health insurance premiums are excluded from taxable income while higher wages are taxable. What happens to the workers covered by those agreements when the tax treatment of health insurance is changed midstream? This concern with fairness was undoubtedly one of the reasons that candidate Obama opposed changing this tax exclusion during last year’s election campaign. But the bottom line is that more than just money is involved, and one cannot change a tax provision that has been in place for more than 60 years without some serious repercussions.

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