CBO eyes employer-based insurance tax exemption

In the 70 years since employer-sponsored insurance benefits have been exempt from taxes, the revenue lost to the federal government has run in the trillions of dollars. Now, with a federal tax code rewrite possible and another looming budget battle, the Congressional Budget Office wants lawmakers to rethink that so-called tax expenditure.

Reducing preferential tax treatment for employer-sponsored health insurance is among 16 options for reducing federal health spending that the CBO is pitching. In a budget options briefing, the agency says it could be one of the single largest sources of savings -- yielding between $240 billion and $540 billion over a decade, on a par with imposing caps on Medicaid spending (saving up to $600 billion) or transitioning Medicare to a premium-support system (saving up to $275 billion).

"In all," CBO staffers wrote, workplace-based health insurance's "favorable tax treatment costs the federal government about $250 billion in forgone revenues each year."

The large risk pools created particularly through the enrollment of large firms' workforces make for "a relatively efficient way to provide coverage--even apart from the tax preferences," they wrote.

"At the same time," the CBO said, "the open-ended nature of the tax exclusions has increased healthcare spending by encouraging the provision of more comprehensive health insurance than would be the case if there were no tax preferences. In addition, the value of the tax exclusions is generally larger for workers with higher income, even though such workers are more likely to purchase coverage anyway."

And even though a new 40 percent excise tax begins in 2018 for "Cadillac plans" exceeding $10,200 annually for individuals, the continuing exemption for most plans will be "substantial," the CBO said, and will continue to largely benefit high earners.

Reducing the tax exemption in some form would have a number of effects, most of them beneficial from the federal government's point of the view. It would raise federal revenues, for one thing, and likely decrease the number of workers with employer-based insurance -- possibly seeing them enroll in private or public insurance exchanges. One large question, though, is whether the Affordable Care Act's employer mandate would be compatible with a reduction in the employer-sponsored insurance tax exemption.

Those benefits would also have to be compared to a number of negative impacts, among them a possible increase in adverse selection.

CBO analysts think that adverse selection would not be a large problem in the nation's insurance market with a scale-back ESI tax exemption, arguing that while the current tax preference helps reduce adverse selection, "those preferences also encourage workers to favor health care over other goods and services they could purchase and thus contribute to the growth of healthcare spending."

The concern is further muted by the fact that workers are picking up increasing proportions of their healthcare costs, with one-third group health plan members estimated to have high deductibles.

All that considered, it's not clear just how likely Congress would be to consider ending the tax deduction, or enacting a new tax, as many Republicans and some Democrats would characterize it, although Montana Senator Max Baucus and others have been working on rewriting parts of the federal tax code. When Baucus, a Democrat who's serving his last term, and Republican Orrin Hatch outlined their plans in June, they said they wanted to start from scratch, eliminating all tax preferences -- except those that "(1) help grow the economy, (2) make the tax code fairer, or (3) effectively promote other important policy objectives."

Ahead of the next fiscal cliff, Baucus and Hatch have unveiled some ideas, none mentioning the employer-sponsored insurance exemption. But if they and other lawmakers are interested, the CBO is suggesting "two broad approaches," modifying the 2018 excise tax or modifying current exclusions.

"The parameters of both the new tax and the current exclusions could be adjusted to yield larger or smaller amounts of additional revenues or to alter the impact on different types of people, employers, and health insurance plans," the CBO said.

Another alternative CBO is pitching would be to replace the current exclusion with an income tax credit, "which could also be designed to generate specific amounts of revenues or to have other specific effects."

If the tax credit was set at a fixed amount and refundable, it would make tax code fairer, the CBO argues: "all workers would receive the same value from the credit, regardless of their tax bracket or their health care costs."