Experts agree that healthcare entitlement reform is key to curbing costs and boosting quality, yet we seem to ignore one of our biggest, less obvious, entitlements in the discussion. After Medicare and Medicaid, the employer sponsored health insurance tax exemption is the government’s biggest expenditure on healthcare, costing us around $260 billion a year. It is the largest United States tax exclusion, and allows workers to exempt any healthcare benefits in calculating their income tax, and employers can exempt the same benefits from the payroll tax. This exemption allows higher paid employees to have an unfair advantage, since they save more money because of their higher marginal tax rate. Therefore two employees could be receiving the same health benefits, with the higher paid employee having more tax savings.
In addition, the tax exclusion incentivizes individuals to enroll in more expensive healthcare plans. More generous coverage leads to moral hazard, which is when people consume more health services because it is covered by insurance, not because they necessarily need it. Let’s not forget the disadvantage it provides for the 26% of the adult population who does not receive employer sponsored health insurance. They are forced to buy their individual health insurance with their already taxed income, effectively decreasing their purchasing power.
Although the Affordable Care Act poorly attempted to even the playing field in the individual insurance market, it seems that a much easier solution would be reforming the insurance tax exemption. Not only is this a fairly easy policy to implement, it also has, gasp….bipartisan support! It has been supported by the Cato Institute, John McCain, and the Centers for American Progress but apparently it still lacks popularity. Understandably, there are some objections to tweaking the exclusion, since it is a significant incentive for employers to offer health insurance. Yet, according to a working paper by Jonathan Gruber, large firms are not at all sensitive to the amount of the tax exclusion, with small and medium firms being only moderately sensitive. There would not be a complete dismantling of the employer sponsored insurance market if the tax exclusion was altered or capped. President George W. Bush recognized this opportunity when he proposed a standard deduction for health insurance of $7,500 for individuals or $15,000 for families. Due to the immediate need for health reform funding, it is imperative that we stop simply cutting payments to providers or raising taxes, but find ways to improve existing policies to make them more efficient. By updating the employer health insurance tax exclusion, the federal government could earn a significant amount of revenue while encouraging employees to understand more about their health insurance coverage.