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.


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.”


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

  1. David, I agree with your worries. I’ve been scratching my head throughout the healthcare debate as people trot forward all manner of statistics describing why the cost won’t be as high as people assume (or even deficit neutral!).

    The sad reality is, REAL healthcare form would have to simultaneously extend coverage and curb the COSTS as well — no other system is truly workable. Does this means that doctors and nurses might get less money? Does it mean healthcare “rationing”? Does it mean cutting into the bottom line of health insurance companies? I think the answer to these questions has to be “yes”. Unfortunately, there is zero political ability to do things like that, we’re going to simply be left with the government subsidizing coverage for millions of americans while the costs continue to balloon. Though this may still be worthwhile — in my mind, healthcare is a top domestic priority– it is pretty clear that any such project is going to be extraordinarily expensive.

    Time to cut the defense budget!

  2. Two points:

    1 You say the CBO doesn’t take into account that “the funding source dries up,” but that seems to be one of their core assumptions.
    My understanding was that the excise tax is projected to raise revenue through the mechanism you allude to: income taxes.

    2 On the notion of perpetual extension of the union exemption:
    Or in other words: unwarranted assumptions are unwarranted. This seems to be the excise tax doing what its supposed to do: encourage people to negotiate for greater compensation in wages rather than in healthcare.

    I’m just going to refer you to Klein on the excise tax, and the healthcare bill more generally, because he’s far better informed than I.

  3. David, you say, “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.” Would you then support the Senate bill? What would you want to do to achieve these goals? Or are you just sort of saying there are compelling arguments, to appear as if you are supportive, but in reality you don;t think the goals are worth pursuing? I’m trying to get a precise sense of where you stand on the issue.

    I ask because, while oyu say the arguments are “compelling,” I question whether you want to actually expand coverage. I think the skepticism is warranted, because you also write, “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.” In other words, you would prefer saving money and paying down the debt than saving money and pouring it into greater coverage. I am just assuming here, of course, but I’d love to hear what you support and don’t support.

    I personally think it is really hard to estimate what will happen with the overall impact of the Senate bill on the deficit. But, even if the deficit were to increase, it would be worthwhile for the sake of broader savings in the system, which you acknowledge. Cost control is such a crucial element, probably second only to the expansion of insurance coverage. The amount of saving in the system is more important to me than what happens to the deficit – there are lots of ways we can address the deficit, plus I am more concerned about long-term, structural deficits/debt than what is accrued in the short run.

  4. Thanks for reading/commenting everybody. Sorry in advance for the long reply.

    Sol, thanks for your links. I checked them out, and you’re right that the CBO took into account the declining number of subscribers to “Cadillac” insurance plans that would be taxed under the bill. I’m still somewhat confused why the revenue increases every year. Do health insurance insurance costs actually increase so much every year, e.g. a near doubling from one year to the next? If so, that’s truly terrifying. As for the other Klein link however, I don’t necessarily see that the CBO and JCT are in fact taking into account the additional revenues from income tax and nothing in their language talks about it. It seems like a pretty complicated calculation to make, especially since the CBO (in your link) blogs about the high uncertainty surrounding how employers would react. I’d actually be curious to see where Klein got his numbers because the only JCT publications I found don’t mention anything about extra collections from income tax ( From the wording of the memos, it really just looks like they are thinking about collections from the excise tax. As for the renewal of the unions… it’s possible that the Democrats might not be in office. But if they are in the majority, I really think they’ll attempt to grant the exemption again, especially when there will be less public scrutiny. This is not the first time Congress has caved to special interests related to health care, and this is no ordinary tax break.

    Billy, I too hope that health care reform in terms of preventative medicine, etc. can reduce health care spending in the future, though it’s not certain that will happen. My main problem with the bill on the table is that I just don’t think the funding is very sustainable and that it really just requires a new tax to be levied in the future, which is hidden today from the average American in order to get the bill passed. To be clear, the main source of funding is still cuts in Medicare, not any millionaire’s tax or Cadillac tax; those are a pittance next to the pound. I already indicated that I doubt Congress has the political willpower to make those cuts, because of its record of not making scheduled Medicare cuts in the past. But even if I believed that Medicare was going to get cut each year, I still wouldn’t love this plan. The reason is because while “deficit neutral” would be a true term, it doesn’t describe the full context–we are deeply in debt and running incredible deficits already. Medicare, along with the Iraq War, was something we already should have been cutting to try and balance the deficit and start paying back the debt (you mention there are a lot of ways to address to deficit, but those are the biggest and most obvious ways); we shouldn’t be cutting it and then just spending the recently realized savings. I talked about this with Josh recently (who disagreed), and the example I gave was a government with $70 in yearly revenues and a single program, A, that cost $100 a year. Five years later, the government is $150 in debt and still running a $30 annual deficit. The government decides, hey, let’s get plan B as well, which costs $30 and we’ll fund it by cutting spending in A by $30. This whole arrangement is neatly “deficit neutral”, but basically entrenches the original unsustainable overspending in the budget. Anyway, to answer your question, I would support an expansion of health care coverage and even universal coverage (with rationing) if Congress would just be honest with America and recognize that we can’t get Europe and Canada’s health care coverage without their higher taxes as well. I don’t think we should hide and defer those inevitable tax hikes, but be up front with the costs. I’d like this legislation to use tax increases to fund the health care expansion, and Congress should separately seek in the future to cut Medicare overspending, obviously spending on the current war, and as Tom mentioned, the defense budget in general.

    • David, I think that the reason the Cadillac tax is supposed to expand each year (and one that I admit may be vulnerable to your criticism) is that inflation expands the amount of plans that would qualify to be taxed. Supporters of the plan (like myself) hope that the Cadillac tax will become a backdoor way to make health care benefits a taxed form of income in general, but critics believe that, like the Alternate Minimum Tax, Congress will continually adjust the threshold for inflation, foiling the hopes that we’ll all be in taxable Cadillac plans someday.

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