Taxing Health Care Benefits: An All-Around Bad Idea

by Mike Hall, Mar 24, 2009

There’s noise now in Washington that policy makers are considering paying for health care reform, in part, by taxing health care benefits workers receive through employer-provided health coverage. Such an ill-conceived plan not only represents a big a tax hike for workers and their employers, but carries serious and hidden costs, according to a new study by the Economic Policy Institute (EPI).

In “Not-So-Easy Money: Taxing Health Care Benefits Comes with Costs,” Elise Gould, EPI’s director of health care policy research, warns

we should proceed with extreme caution before moving to cap or eliminate this tax exclusion.

The latest government figures show that in 2007, 70 percent of the 253 million people with health insurance received at least some of their coverage through employers. Currently, the money spent on providing health care coverage is tax deductible to the employer and the employee is not taxed on it.

Workers who get their health care coverage through employment, and the employers who provide it, already have seen years of their costs climbing and their coverage shrinking through higher premiums, bigger co-pays, larger deductibles and more exclusions in coverage.

On top of that, workers’ paychecks have stagnated as they have given up pay raises to funnel those funds to cover the higher health care costs and maintain coverage.

UAW Legislative Director Alan Reuther recently told The New York Times that proposals to tax health care benefits

would represent a tax increase on working families. They would undermine good health care coverage.

Not only are the proposals a tax hike on workers, but, says Gould, they also could accelerate the decline in employer-provided coverage.

The current policy of excluding health benefits from taxation provides employers with an incentive to offer health insurance to their workforce. When large groups of workers (and their families) sign-up for health insurance through employers, “risk pools” are formed. The key to these risk pools is that people are not grouped according to their health, creating a viable and stable insurance pool.

Taxing health insurance benefits would encourage the young and healthy to opt out of these pools; upon their exit, premiums would likely rise for those remaining.

Consequently, a policy that taxes health benefits would likely accelerate the substantial erosion in employer-sponsored insurance that has occurred since 2000 and thus cause more people to lose insurance coverage altogether.

Those pushing the health care tax also claim it would reduce health care costs by discouraging workers from so-called “wasteful” health care spending and steering them away from more comprehensive, quality coverage to lower-cost, more bare-bones coverage. Says Gould:

…taxing high-priced health coverage will heavily burden two groups: workers in small firms and workers in employer pools with higher health risks, such as those with a high percentage of older workers.

Small businesses are paying high premiums for the insurance they provide to their employees not because the plans are especially lavish, but because they have high administrative costs and include too few employees to constitute the broader risk pool that would qualify them for lower premiums.

Employees whose characteristics cause them to be classified as higher risks make them more expensive to insure. Adding a tax on top of the cost of premiums they and their employers pay will likely drive more of them into the ranks of the uninsured.

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