Capping the Tax Exclusion for Employment-Based Health Coverage: Why Obama Is Not Going Back On His Word

Yesterday, during an appearance on Fox News Sunday, Austan Goolsbee, a member of the White House Council of Economic Advisers refused to comment on whether the administration is seriously considering taxing health benefits to finance health care reform:

That is not in the President’s budget…it does not include this provision. This appears to be coming from the administration and representatives of the administration who went to Congress and said we are open to all ideas to pass health care reform…there are some people in Congress who are pushing for this, but that is not the President’s idea….he is open to all ideas. He said, let’s put all ideas on the table. That is not the president’s idea. It is not in his health care plan, it is not in his budget.

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The press has argued that the “proposal is politically problematic for President Obama,” since it is similar to one he denounced in the presidential campaign as ‘the largest middle-class tax increase in history.” But in reality, the the consequences of Obama’s proposal are quite different.

The problem was never the tax exclusion itself. Rather, progressives were concerned about what would happen to individuals who lost their employer-sponsored health coverage once the tax code changed. McCain proposed replacing the employee deduction with a one-size-fits-all tax credit without reforming the health insurance market or expanding access to group coverage. Under his plan, Americans who lost their employer coverage would have had to fend for themselves in an unregulated individual health insurance market; Americans with pre-existing conditions would have joined the ranks of the uninsured.

Obama is using the measure as a means to finance comprehensive reform. Should someone lose their employer-based coverage, they will be able to purchase affordable insurance through a regulated exchange that cannot deny coverage to Americans with pre-existing conditions.

The theory behind capping the health exclusion rests on the assumption that the tax-preferred status of employment-based health coverage leads workers to over-insure and use more health care services than they otherwise would. Overuse of insurance drives up insurance premiums and makes coverage less affordable for lower-income workers.

The Congressional Budget Office (CBO) estimates that the exclusion of employer paid health insurance from income taxes costs the government about $145 billion and the exclusion from payroll taxes costs $100 billion. And the savings only increase over time. As CBO chief Douglas Elmendorf explained during a recent Senate Budget Committee hearing:

All tax provisions grow to some extent over time because the economy grows and prices rise, but this — the value of this exclusion grows with health-care spending over time. So, our estimate of the value of this provision, I think more specifically the way the Joint Tax Committee estimated some of these options has growing over time with health care spending because whatever employers end up putting into health insurance does not count as taxable income.

In fact, Elmendorf argued that “the cleanest and strongest level that you have about private health care is the tax exclusion. As I said in my testimony, I think many analysts would agree that adjusting that exclusion can be very beneficial for health insurance coverage and for ensuring a more efficient health-care system.”

The approach, which would allow Obama to finance a large portion of health care reform with money that’s already in the system and please conservative Democrats and some Republicans who don’t want to pump new money into health care, isn’t without its problems. A Employee Benefit Research Institute Brief concluded that capping the tax exclusion for employment based health coverage could become “a complicated and administratively costly burden” for self-insured employers and warned that workers would “face a variety of equity issues if the tax exclusions of health coverage were capped.”