The Hidden Subsidy That Helps Pay for Health Insurance


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As Republican senators work to fix their troubled health care bill, there is one giant health insurance subsidy no one is talking about.

It is bigger than any offered under the Affordable Care Act — subsidies some Republicans loathe as handouts — and costs the federal government $250 billion in lost tax revenue every year.

The beneficiaries: everyone who gets health insurance through a job, including members of Congress.

Much of the bitter debate over how to repeal and replace the law known as Obamacare has focused on cutting Medicaid and subsidies that help low-income people buy insurance.

But economists on the left and the right argue that to really rein in health costs, Congress should scale back or eliminate the tax exclusion on what employers pay toward employees’ health insurance premiums. Under current law, those premiums are not subject to the payroll or income taxes that are taken out of employees’ wages, an arrangement that vastly benefits middle- and upper-income people.

That one policy tweak could reduce health care spending, stabilize the health insurance market and, according to Congressional Budget Office estimates, shrink the federal budget deficit by between $174 billion and $429 billion over a six-year period

Lawmakers briefly pondered the idea this year but quickly abandoned it, recognizing how politically explosive it would be. Still, as Congress seeks to push ahead with major changes to the health system and the tax code, there has been a growing awareness of how long-established tax subsidies — like the mortgage deduction for homeowners — have contributed to economic inequality in the United States.

Republicans who have been fighting for seven years to repeal the Affordable Care Act argue that the Medicaid expansion has cost too much, that the subsidies for lower-income insurance customers are in some cases handouts. Senator Orrin G. Hatch of Utah, the chairman of the Finance Committee, likened the expenditures recently to “the dole.”

“The public wants every dime they can be given,” he told reporters in May as he left a health care meeting to explain the difficulty in cutting those programs. “Let’s face it, once you get them on the dole, they’ll take every dime they can.”

The tax exclusion, though, is also a subsidy, one that disproportionately helps the affluent, who are more likely to receive generous health benefits from an employer and who fall into higher tax brackets, making the tax break worth more.

A 2008 study by the Joint Committee on Taxation found that not paying taxes on these benefits saved people with incomes less than $30,000 about $1,650. For people with incomes above $200,000, the average tax savings was $4,580.

The Affordable Care Act required companies to start reporting the value of employer-sponsored health benefits on W-2 forms (Box 12; Code DD). But most people don’t even realize they get a subsidy typically worth thousands of dollars a year.

For the federal government, the health benefits exclusion is the single largest tax expenditure, accumulating over the next decade to about 1.5 percent of the nation’s gross domestic product. (Economists say it is effectively the federal government’s third-largest health care expenditure, after Medicare, which cost about $581 billion last year, and Medicaid, at $349 billion.)

It costs five times as much as the subsidies the Affordable Care Act set up to help people buy health insurance, which are estimated to total $49 billion this year. And it is far more than the $70 billion the federal government is spending to expand Medicaid under Obamacare this year.

But few lawmakers, Republican or Democrat, have ever argued to change the exclusion. The closest Congress came to making the system more progressive — that is, to make it scale up according to income — was the so-called Cadillac tax included in the Affordable Care Act.

That was supposed to tax the most generous employer benefits to help pay the subsidies in the law, but its effective date got pushed back to 2020. Both the Republican House and Senate health bills shove it back further, so long — a decade in the Senate bill — that many analysts say it is unlikely to ever take effect.

What Different Health Policies Cost

“This seems like a natural place to look for revenue to expand coverage,” said Stephen Zuckerman, a senior fellow and co-director of the health policy center at the left-leaning Urban Institute. But, he said, “It becomes a political problem.”

Business groups, which tend to back Republicans, argue that a cut in the tax exclusion is a tax increase; labor unions, which tend to support Democrats, say it will lead them to lose benefits at the same time their wages have stagnated.

“We don’t think it does the things economists say it’s going to do,” said James Gelfand, senior vice president for health policy for the Erisa Industry Committee, which lobbies for large employers. “Ultimately these proposals are designed to end the employer-sponsored system,” he said. “They’re not indexed to reality.”

The benefit began with the wage controls of World War II. Employers got around those limits by offering more generous health benefits, and the Internal Revenue Service and later Congress said those benefits did not have to be taxed.

Employer-based health insurance now covers more than half the non-elderly population in the United States. The average premium in 2016, according to the Kaiser Family Foundation, was $6,435 for an individual and $18,142 for a family, and the tax exclusion reduced the cost of insurance by about 30 percent.

Even economists who dislike the exclusion recognize its benefit: It pools risk, the way some countries have done with national health insurance, and reduces adverse selection by encouraging the healthy to buy insurance.

But economists also argue that the exclusion creates perverse incentives that drive up the cost of coverage. Studies have found it encourages workers to buy more expensive insurance and to use more medical services than they need.

“Because we have invented a system where most people have extremely generous coverage, no one asks about the price, and no one tells them what the price is,” said Joseph Antos, an economist and scholar in health care policy at the American Enterprise Institute, a conservative think tank.

Every year the Congressional Budget Office analyzes options for reducing the deficit, including reductions in the tax exclusions for employer-provided health insurance.

In its 2016 analysis, the C.B.O. found that imposing income and payroll taxes on premiums higher than the 50th percentile beginning in 2020 — this would be contributions above $7,700 a year for individuals and $19,080 for families — would cut the federal deficit by $429 billion by 2026, more than either the House or Senate health bills would achieve, according to C.B.O. analyses.

It would also cause four million fewer people to have employer-based health insurance, the analysis found. Half of those people would go to health insurance exchanges set up by the Affordable Care Act, fewer than 500,000 would enroll in Medicaid, and one million would remain uninsured.

Subjecting premiums at the 75th percentile or higher to payroll and income taxes beginning in 2020 — premiums higher than $9,520 for an individual and $23,860 for a family — would reduce the deficit by $174 billion by 2026, the C.B.O. found.

Economists bet that employers would pay less for health insurance and pass on that savings in the form of higher wages. But business groups and business owners say that is unlikely.

Particularly in high-cost states, employers say offering a less attractive package of health benefits hurts their ability to hire.

“Good employees are the most important resource companies have, and this is part of the landscape that folks expect,” said William McDevitt, a shareholder with Wilkin & Guttenplan, an accounting and consulting firm in New York and New Jersey. “Messing with that matrix to generate revenue, I just see it as anarchy, politically.”

Even if companies did increase wages, employees would have to pay higher taxes, leaving them with less money to buy health insurance.

“You’re going to tell every employee they’re going to pay 20 percent more in federal taxes? Is that going to change what they need and their behavior?” asked Bill Grant, the chief financial officer of Cummings Properties in Massachusetts, a real estate firm that spends about $2 million a year to pay about 70 percent of the health insurance premiums for its 350 full-time employees. “And if part of that premise is that they are using more than they need, is paying more to Uncle Sam going to change that lifestyle? I don’t think so.”

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