Tuesday, July 7, 2009

Is the Tax Man Coming After Employee Health Benefits?

One of the major disputes in the ongoing discussion on healthcare reform has been whether or not we should tax employer based healthcare. You may recall that John McCain proposed this idea in the 2008 campaign.

Politically, this will be difficult. Most Americans get their health insurance as part of their compensation for their jobs. So a tax on every dollar of health insurance provided will be a tax that hits the middle class. Not coincidentally, it would also break Obama’s pledge not to raise taxes on people making under $250,000 a year. Raising taxes on such families during such a deep recession is sure to hurt the prospects for passing a bill this year. Moreover, taxing the benefits is sure to run into opposition from labor unions, whose members often get health insurance on the job. Labor is of course a core constituency for the Democrats.

But there is no denying that taxing employer-based benefits would raise a good deal of money. Every year, $246 billion would flow into federal coffers if every employee had to pay taxes on their health insurance provided on the job. This money would go a long way towards making a universal healthcare scheme deficit-neutral.

There is certainly a case to be made for taxing such benefits apart from the money it would raise. First, exempting employer-based health insurance is arguably unfair to people who don’t get health insurance on the job. Let’s take the example of two people who both make $60,000. One gets a $10,000 policy on the job, while the other has to pay $10,000 a year out-of-pocket to cover his family. The two are probably paying the same taxes (let’s assume that they’re taking the exact same deductions for the sake of simplicity). That leaves one man paying taxes on his entire income, while the other is paying taxes only on $60,000 even though his true income is $70,000.

The greater the benefits provided, the more unfair this tax scheme becomes. An investment banker (the ones who are still left) who gets a gilded $20,000 plan is getting all of that tax free while a struggling working class man has to pay taxes on his whole salary AND buy his health insurance out of pocket.

Second, many conservative economists argue that our current employer based system distorts the market. Employees are shielded from the true cost of the medical care they use, since another party is paying for it. In high end plans that have no deductibles, or very low deductibles, they have no incentive to limit the medical services they use, even if the care isn’t necessary. This makes the health care system much more expensive than it has to be.

When employer plans are taxed for their full value, consumers will become more cost-conscious, and opt for lower cost plans with higher co-pays and deductibles. This will reduce costs overall in the system as consumers avoid paying for unnecessary care.

Whatever the merits of the tax, there is no way the Obama administration would be able to tax all employer-based benefits. Maybe they can settle for a compromise where people making over say $200,000 pay taxes on their benefits. That would at least raise some money.

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