The “Cadillac” tax can’t finance health care reform.

MIT Economist Jonathan Gruber recently wrote in the Washington Post in support of the Senate proposal to enact an excise tax on “Cadillac” health care plans, a “40 percent assessment on insurance plans with premiums of more than $8,500 for singles and $23,000 for families. In the House, the gap is closed with a surtax on those earning more than $500,000.” In some ways the “Cadillac” tax will be good for employees because they won’t “see” the tax themselves; it would be paid by their employers. In fact, employers will be encouraged to divert money from health care benefit spending to wages in order to avoid the tax, which should please wage-earners. But at the end of the day employees will receive less total compensation since the extra earnings will be taxed as income, and because they will have difficulty purchasing the same “Cadillac” level of health insurance, assuming they want it. Gruber argues that the tax works because it bends the curve, is eminently progressive, and because it corrects an existing tax bias.

The assessment proposed in the Senate is not a new tax; it is the elimination of an existing tax break that is provided to exactly these firms. Under current law, if workers are paid in wages, they are taxed on those wages. But if they receive the same amount of compensation in the form of health insurance, they are not taxed. As a result, the tax code has for years provided a large subsidy to the most expensive health plans — at a cost to the U.S. taxpayer of more than $250 billion a year. To put this in proportion, the cost of this tax subsidy to employer-sponsored insurance is more than twice what it will cost to provide universal health coverage to our citizens.

I completely agree that the Cadillac tax will, as Gruber predicts, “bend the curve” and change the incentive structure for employers. As he writes, “it would reduce the incentives for employers to provide excessively generous insurance, leading to more cost-conscious use of health care and, ultimately, lower spending.”

For that exact reason, taxing health benefits seems  counterproductive. I think what will likely happen is the market will reconfigure, as Gruber says, and companies will start offering fewer ‘Cadillac’ health plans. The reason they offered them in the first place was that it was the cheapest way of differentiating benefits with other firms since the plans aren’t taxed and taken, as I understand it, out of gross earnings instead of net profit. It  doesn’t seem like a good long-term way of funding public health programs or rebates because if behavior actually changes (as is the goal of any excise tax), then the funding source dries up.

It’s sort of odd that the CBO doesn’t seem to be taking this into account very much. The CBO estimates that revenue from the excise tax will go up every year that it’s collected, from $7 billion in 2013, $13 billion in 2014, all the way to $35 billion in 2019. The numbers should naturally go up as health care becomes more expensive, and with inflation, but there’s no evidence that there is accounting for a reverse effect when employers decide they no longer want to pay the excise tax (at least the CBO isn’t explicit about it, and I guess technically the rate of increase is slowing). Why aren’t the numbers going down every year as businesses stop providing, as Gruber predicts, excessively expensive health care plans? Why would any business keep the Cadillac plans once they are being taxed on it (and which are less visible as a benefit), and not just divert the difference to increased salaries?

Revenue from "Cadillac" tax (in billions)

I started writing this before the recent “accord” in which America’s future is sold out once again to labor unions. Labor unions, which negotiate for these excessively expensive health care plans, would be exempted from paying the new tax for 5 years. According to a union representative (not even the CBO), this would reduce the revenue of this tax by 40 percent, to $90 billion from $149 billion over ten years. I suspect the true revenue reduction would be a lot more, when estimated by an unbiased source. Let’s also keep in mind that while the unions are scheduled to start paying the tax in five years, reasonable people suspect that the Democrats will cave in again and give the unions another exemption when the time comes. As in their analysis for the rest of the health care bill, the CBO must assume Congress will actually keep its word and start charging unions in 5 years, so we can be sure that whatever the new cost estimate is, it will be far less than the true cost to America. If Gruber thinks that it’s unfair that businesses basically steal billions from the taxpayers every year through their lavish tax breaks, he (and the voting public) should be just as incensed now that the unions, like the Nebraskans, are getting special benefits at the cost of the average American taxpayer.

What’s deceptive is that the Cadillac tax in the Senate bill gets a lot of press, but it represents only about 15% of the estimated offsets from revenue expansions and spending cuts that will keep the spending bill in the black. If the tax is as good as affecting behavior as other excise taxes, and Congress caves in as easily to other special interests as it did to unions, I foresee little long-term “deficit reduction” or “deficit neutrality” from  health care reform. The real key to offsets is not reducing overspending by businesses, but by (get this) government-run healthcare plans.

Just as Congress has waived ostensibly “automatic” cuts in Medicare (provided by the Sustainable Growth Rate formula) each year since 2003, politicians in Congress will indubitably start waiving the Medicare spending cuts that make up about 50% of the offsets in the Senate bill as soon as the AMA and AARP start clamoring. They couldn’t stand up to labor. How will they stand up to the AARP? Here’s more fodder for the cynics out there. These cuts aren’t scheduled until 2011, after the midterm elections. Congress is deferring growing a spine until after they get reelected, but there will always be another election after that, and always another reason not to anger the large senior citizen constituent group.

And what about after 2019? Are there still going to be Cadillac plans to tax, or billions more that can be cut from Medicare to keep financing increasingly expensive subsidies? Where will the next ten years of funding come from?

Deficit neutrality is a pipe dream that’s used to sell gullible voters on the health care bill. Federal savings are fungible, and we could be saving money on Medicare cuts or excise taxes even without adding billions in subsidies for health insurance. It’s time for people to face the truth. Don’t get me wrong; I think there are very compelling arguments for expanding coverage, and importantly, creating more efficiency in our health care system. But if we want universal health care in this country, or anything close, Americans need to be told how much it costs, and we need to be willing to pay for it.

p.s.

One final word is that I’d encourage people to actually read the CBO reports on the House and Senate bills, rather than getting all of their information filtered by the press. Check out this insane proposed spending cut in the Senate bill, that I bet you never read in the NYTimes:

“Reducing Medicaid and Medicare payments to hospitals that serve a large number of low-income patients, known as disproportionate share (DSH) hospitals, by about $43 billion—composed of roughly $22 billion from Medicaid and $21 billion from Medicare DSH payments.”

Why do Americans hate the estate tax?

The “estate tax” is a tax on money and property transferred from the estate of a dead individual. It’s getting a lot of press recently because it’s set to expire in 2010 (and return in 2011). As it currently stands, 2009’s rate is up to 45% on estates over $3.5 million, and 2011’s will be 55%. As a bit of a side note, I’d like to see the death rate (and suicide rate and gift-giving rate) among wealthy elites in late 2010 compared to the same periods in other years.

As a NYTimes editorial describes, the qualifying threshold right now is so high–$7 million for couples and $3.5 million for individuals–that 99% of estates in America will never qualify for it. Yet according to a Harris Interactive poll cited by Forbes, “two-thirds of those surveyed in 2005, 2006, 2007 and 2009 said they favored “completely eliminating the estate tax, that is, the tax on property left by people who die.” This is despite only 17% of individuals believing they would personally benefit from a repeal of the estate tax.

It’s interesting that only 1% of estates qualify for an estate tax as it’s currently written (though with the expiration of the current estate tax law in 2010, the rate will increase from current levels 10% in 2011 the number, and the number affected could increase due to a triggering of new capital gains provisions), and yet 17% of Americans think they’ll benefit. For one, it indicates that a large number of Americans (the gap between 17% and two-thirds) are not thinking about personal benefit but the fairness of the tax itself. The estate tax is consistently ranked as one of the most unfair taxes the government imposes, compared to income tax, Social Security, excise taxes, etc. After paying taxes on my income once before I could use it to purchase an item, and a second time through sales tax in buying it, why should I have to pay it a third time when I die? If I don’t have any liquidity, why should my transfer of say, an heirloom diamond ring or a family beach house, be restricted because my poor nieces and nephews can’t pay the tax on the expensive property?

Personally, I admit that I’m not unmoved by these arguments, but there’s also a lot to like about the other side as well. First, I should say I hate it when people say “this tax will never affect you”. A tax, or any law, should be good on its merits, not because its unfortunate impacts are limited to a small minority. The first reason is of course, like any disproportionate tax on the rich, that it’s a good way to raise a lot of money, and assuming we’re spending the same amount of money, that will help reduce the amount of taxes collected by the poor(er)–it’s a great progressive taxation scheme. This is just another way we tax the rich more because they benefited so much from the system, and the poor on whose backs their wealth was built could use a little break. Another reason to have an estate tax is that it helps break-up oligarchies of the uber-rich, which might otherwise uncatchably grow generation to generation and come to dominate society. It’s not only about the concentration of power here, but the gradual inability of those without inheritances to penetrate the exclusive sphere, and importantly, stagnation of ability and creativity in that sphere of power.

But what about the gap between 1% and 17%, the number of estates actually affected and the number of people who think they’ll be affected? Surely some have drunk the Republican kool-aid about a “death tax” and how this will be the end of small businesses. I think there’s another group that simply think that they’ll work so hard and make so much money that they’ll end up in that 1%, a sort of nobler and more American version of the classic fool who thinks he’ll be the one to win the lottery. I think a number of the 17% know it’s a good/fair tax to have, but don’t want it just in case they want to be evil in the future–that just in case they get to be in that top echelon of wealth, there will be no estate tax when that happens. It’s like recognizing that there’s a huge tax loophole existing, and wanting to keep it open just in case you’ll want, or be in a position to, use it in the future. Just in case we decide, when we’re rich, that we want to be greedy, we’d like the ability to do so. Perhaps there’s even a group of people who think, “just in case I want to commit a crime one day, I’d like government surveillance to be slightly weaker and defendants’ rights to be slightly stronger.”

Here a good example of this “just in case we want to be evil” phenomenon. Senate Democrats, despite controlling a majority and supermajority of the chamber and complaining about the unfairness of the filibuster refuse to do away with it because each of them harbors some hope of being in a position to hamstring important legislation from the majority when the shoe is on the other foot, even though it would be just as unfair. From Balkinization:

That being said, I think the odds of modifying the Senate rules are close to 0%, unless the Democrats are really willing to confront the oldest continuing myth of the Senate, which is that it is a continuing body whose rules can be amended only in accordance with pre-existing rules, which, as my previous post indicated, requires a 2/3 vote. It is literally inconceivable that Republicans would acquiesce in such a move while the Democrats hold power or, frankly, that Democrats would acquiesce if the situation were reversed. Now perhaps Joe Biden will rule that rules can be changed by a straight majority vote. I still would be extremely doubtful if 50 Democrats would vote for that, simply because they can envision being back in the minority when they will want to torpedo Republican legislation. (After all, the Senate can’t even cure the absolutely pernicious custom of “holds,” which allow single senatorial tyrants to tie up nominations, presumably because each senator envisions the possibility that he/she will want to exercise that bit of petty tyranny him/herself.)