Jun 11 2009, 10:22AM
Three Questions About Max Baucus and Taxing Health Care
It's nice to see Finance Committee Chairman Max Baucus moving towards capping the tax exclusion for employee health benefits. (As it stands, employer-offered health plans are exempt from payroll and income taxation, unlike most other forms of compensation.)
The problems with the current health-care tax exclusion are numerous and worth repeating. First, the exclusion is poorly targeted. The largest benefits go to the employees with the largest incomes, who would have the least trouble paying for healthcare on their own. Second, subsidizing the plans offered by employers increases labor market rigidity. Workers have any easier time leaving or switching jobs when they don't fear losing swanky coverage. Third, there's a lot of revenue at stake. The tax exclusion has been described as the largest single subsidy in the tax code. In 2007 it reduced federal tax collections by $246 billion.
But perhaps the biggest problem is that it gives employers and employees an incentive to offer more generous plans and consume more luxurious health services than they otherwise would. The subsidy leads to an increase in demand. The increase in demand raises the price. Health care doesn't get any less expensive.
So it's good to see Baucus moving in on these problems. That said, I have three questions/concerns about his (still evolving) plan to cap the tax exclusion. They are:
1. Capping the exclusion raises equity issues. The Washington Post says Baucus wants the cap to start at plans costing $13,000 for a family of four. But health-care premiums can vary for reasons other than the generosity of a plan. There's geography (some regions are more expensive than others), the age and health of the taxpayer, and the size of the employer in question (small firms have higher administrative costs than larger ones). If what we want to limit is the overconsumption of services, capping the tax exclusion on the basis of the premium is imperfect. (Stan Dorn of the Urban Institute had an interesting paper on this recently.)
2. Capping the exclusion raises tax-progressivity issues. There are two basic ways to cap the health-care tax exclusion. The first is to cap based on the value of the plan. This is what Baucus wants to do: Plans worth more than a certain amount will no longer be excluded from federal taxation. But you could also cap the exclusion based on the income of the employee -- ie, employees with incomes above a certain threshold would see the health benefits tax phase in and increase, much like the income tax itself.
Or better yet, you could combine the two methods. Is there any reason not to do that instead?
3. Why exclude union benefits from the cap? Reportedly, Baucus wants to do this. I understand that this might be a necessary compromise. But, as Ezra Klein points out, it's hard to see why benefits achieved through collective bargaining should be considered different, for tax purposes, from any other kind of employee benefit. (It's even more difficult to see why unionized employees of companies that are now de facto owned by the federal government should be entitled to more generous plans than other employees of the federal government.)
What am I missing?
I agree on (3). Concerning (2), I think we need to be careful to maintain people's incentive to work hard and attain higher education. Needless to say, household calendar year ordinary gross income is probative but insufficient to determine people's ability to afford government taxation. With marginal ordinary income rates rising above 50% for duel earner entry level professional households (36% federal in the second highest tax bracket, 2.9% Medicare, 8.5% local in DC, at some point an uncapping of the payroll tax), I think it is misguided to add on even more disincentives towards hard work and higher education such as Mr. Clarke's proposal here. At some point, people will work less, defer more income, and recharacterize more ordinary income as capital gains and dividend. People will also choose to trade off more ordinary income in exchange for better work/life balance, better traning and mentoring opportunities, or better benefits, all equivalent renumeration that is essentially untaxed.
I agree that (1) is a concern. On the other hand, there are worse things in life than being subjected to taxation. If taxation of benefits is really this burdensome, we should consider simply lowering marginal tax rates on ordinary income to make it more affordable, and replacing the lost federal revenue with other forms of taxation such as a VAT tax, a higher carbon-based fuels tax, or eliminating personal deductions like charity, union fees, or home mortgage interest.
#3 actually does have a good explanation. The proposal is to exclude union benefits only on the current contract; not future contracts ("And it would be likely to "grandfather" in health benefits set as part of a collective-bargaining agreement, he said, allowing union plans to remain tax-free until new contracts can be negotiated.")
This makes perfect sense because union contracts and wages change less often than elsewhere in the economy.
At the margin, workers will value health insurance at less than the cost. If you are in the 30% tax bracket, when an employer spends $1 on wages you get $0.70, but when an employer spends $1 on health insurance you get $1 of health insurance. So if an employer allocates compensation between wages and health insurance optimally, the worker values the last dollar of health insurance at less than the last dollar of wages. We'll say for simplicity that you only value $1 of health insurance at $0.80.
If you cap the exclusion at $13k, then on an insurance plan that costs $18k the worker values the last $5k at only $4k. Hence, if the last $5k is taxed as wages, they'd rather have, say, $4.5k in income than the $5k in health insurance.
In their next contract, they'll want a $13k health insurance plan and a $4.5k pay raise, but until then it would be "unfair" to tax them on the full $5k.
Since non-union workers have wages re-adjusted at much higher frequencies than union workers, it makes sense to wait to tax benefits of workers covered under collective bargaining until they have a new contract.
Are you writing under a pseudonymn? The same article appears on my Atlantic feed under Derek Thompson's name. What's up?
fraid not. I think that happens whenever something I write for my blog gets crossposted to the business site. But there's no pseudonym issue. It's just s really terrible and imperfect way of handling crossposting, and we're working on improving it.
(I think.)
Conor
Companies give out health insurance as a way of increasing compensation. They supposedly started doing it as a way to avoid government controls on wages. If the employee could get exactly the same thing for the same price in the market, employer-provided health insurance would disappear. They would just pay more salary instead and get out of the insurance purchasing business.
That's not the case however. Employees with health issues would have to pay a lot more than a company does to include them on a group plan. And employees with families are massively subsidized at the expense of single employees when the employer pays. The employer does not take the extra cost out of the salary of the married-with-kids employee.
The tax treatment is only significant if its different for employer provided insurance vs. individually purchased insurance. If you are self-employed, I think there's a tax deduction for insurance. Not sure what the deal is if you buy your own insurance while employed.
The politics of this is that single-payer fans hope that eliminating the tax deduction will make employers drop coverage, passing a huge cost to employees, who then support government provided care. It would also eliminate the lobbying from companies over health care costs, since they would not be responsible.
The union exemption is also pure politics, as I'm sure you all really understand, despite hair-splitting arguments about fairness.
The tax argument is the usual idea that the government owns the economy and all income, and any tax relief is a "loss to revenues". Blah!
I think the worry is the extent to which it distorts the market, as well as the issue of horizontal fairness. (If you're self-employed, you can deduct from income tax but not payroll tax. You get no tax benefit if you buy insurance in the private market. Then there's all sorts of questions about the size of the firms, etc.) It doesn't seem obvious to me that only lefties should support reducing or eliminating the preferential tax treatment.
I thought commenter Maybe's response to #3 was pretty good! At least it convinced me..
Conor
The result of #3 is that a non-union employee sees an immediate rise in his taxes, or a rise the next time he gets a job (if you grandfather current employees, which they are not talking about). The union guy doesn't see any increase now, or until his contract changes. I don't see any fairness to this at all.
The caps are all about "screw the rich, they can pay for their own health care." So are these arguments about firm size and "distorting the market."
These arguments about who is "entitled" to more health care are discouraging. You guys really put different people in different categories on this stuff, don't you? No concept of health care as just another service that you can buy if you like, to whatever extent that you like?
I guess the background to this is that health care has been deemed a "human right" by the left. And not just any old health care, but the best there is. And they regard it as a basic unfairness if rich people get more of this "human right" than the poor.
The fact is, other than basic public health measures, vaccinations, prenatal care, etc., not much of health care actually raises life expectancy. I did a little research on this, and wrote it up on my blog:
http://www.free-the-memes.net/writings/healthcare.html
The bottom line is that there's been a nearly 30 year improvement in life expectancy between 1900 and 2000. But, if you look at the timing of it, a third is before 1940, when there's no "real" medicine by today's standards (not even antibiotics.) Another third is before 1970, when there's nothing like hi-tech health care. The last third is in the modern era of exploding health care costs. And I point out that lifestyle makes a lot more difference to longevity than health care does. Our current system is really about intensive care for the elderly, adding very little in the way of lifespan. The "$100,000 funeral" in other words, although I think the price is higher than that now.
So the real consequences of health care reform are not increases in lifespan, and not really access to care by the poor. The 45 million figure includes 12 million illegal aliens, and some huge number of people between jobs. They all get basic care in emergency rooms. So all that "universal" health care is going to do is cut wages of doctors and nurses, ration care, push rich people into a completely private system, and cost the government unbelievable amounts of money.
As the saying goes, "If you think health care is expensive now, wait until it's free!"
This is not just cynicism. It's the pattern you see in Canada, Australia and the UK. I don't see any reason to think we'll do better. And BTW, I'm not just saying this as some rich techie. I'm disabled and on Medicare. I dread the system you guys are putting together.
I think when McCain's campaign adopted Jason Furman's idea to eliminate the exclusion, they included a tax credit that would offset the increased tax base. McCain's plan met the objectives of loosening market rigidty, aligning the payer with consumer (reducing the incentive to overconsume) and, last, the credit (as opposed to a deduction) has neutral impact on tax progressivity.
On Conor's Item #2: I buy my own health insurance. When I file my taxes, I add up my insurance premiums and my unreimbursed health care bills; that total is considered my "medical and dental expenses". I can deduct only the amount of my medical and dental expenses that is more than 7.5% of my adjusted gross income.
This effectively adjusts deductibility based on my income. Let's say two people both pay $5000 a year for their health insurance; one person makes $75,000 and the other makes $25,000. Assume no other medical or dental costs. The first person will not be able to deduct any of his health insurance premiums while the second will be able to deduct $3125.
It seems to me the simplest approach to taxing employer provided health care would be to call the amount paid for an employee's health insurance both income and a payment toward health insurance by the employee. Then treat it the same way we now treat health insurance payments by individuals who buy their own: deductible to the extent the payments combined with other health expenses meets the 7.5% threshold. (This sort of addresses Item #1 if we assume areas with higher medical costs also have higher salaries.) On the other hand, if Mr. Baucus wants to exempt some employees from taxation, I'd like the same exemption please.
Of course the simplest approach overall would be to do away with all deductions for everything and tax everyone on everything they make including non-cash compensation. Progressive income tax rates, same rate for all types of income. Totally transparent, we can spare ourselves these endless discussions about which method is "fairer"(I can see both sides on the union issue), and people aren't making income (or life) decisions based on whether they can fiddle the tax system. Plus it would take 5 minutes to do your income tax - including finding a postage stamp.