Mo’ Money, Less Generous Health Insurance (But Lower Overall Costs and a More Equitable Distribution of Coverage)

The idea of taxing health insurance benefits entails a lot of complexity, but in a general sense it comes down to a pretty simple question. Do you think that John, who earns $80,000 a year and gets an insurance plan worth $8,000 should pay more taxes than Jim who earns $70,000 a year and gets an insurance plan worth $18,000? After all, John and Jim are both getting $88,000 worth of compensation so it seems like they should pay the same in taxes. But under the current system, Jim pays substantially less. This has the effect of encouraging the Johns of the world, and their employers, to switch compensation packages from John-style “high wages, modest health benefits” to Jim-style “lower wages, better health benefits.” In the Jim-o-verse, copayments are lower and you have more access to specialists. Then again, in the John-o-verse if you want to see a doctor you have more cash in your pocket with which to afford the copayments if that’s what you want to do.

On the face of it, this is a no-brainer. Having the tax code encourage Jim-style compensation packages rather than John-style packages is a big economic distortion. What’s more, by artificially subsidizing health care consumption by the relatively prosperous, it drives prices up for everyone, including the not-so-prosperous. And because it’s a tax-side subsidy, the subsidy does little-to-nothing for the poor.

So scrapping or curbing the subsidy makes sense in general. And it especially makes sense as a way of raising money to finance progressive policy like ensuring that health care is affordable for the poor and the lower-middle class. But there are a few problems with just scrapping it. One is that suddenly altering the status quo in this regard could be very disruptive to a lot of people. The other is that, as John McCain discovered, it sounds politically toxic. The answer to the first problem is pretty easy—you cap the tax subsidy in a way that leaves almost everyone unaffected in the short term but that phases the subsidy out over the long-term. The answer to the second problem is courtesy of John Kerry who suggested that we levy the tax not on the buyers of expensive insurance plans but on the sellers. The impact of this is basically the same (Ezra Klein notes the small difference) but since people don’t understand tax incidence it could be politically easier.*

The two major advantages of relying on this method of financing health care are that (1) it “bends the curve” by encouraging people to take more of their earnings in the form of money (which of course can be spent on health care but also on other things) rather than health care services, and (2) it lets you stay deficit-neutral over the long-haul. What the House has done, by contrast, is deficit-neutral inside the three-year window but not longer than that.

The big problem with Finance’s excise tax, I would say, is that it doesn’t actually raise enough money. Hence, Finance has subsidies that are stingy relative to what the House is proposing. What’s more, CBPP has a good analysis out support an excise tax but also calling for several modifications that would lead to the tax raising even less revenue in the short-term. The solution to this, I think, is to modify Finance’s proposal à la the CBPP and then also tack on a dose of the House’s surtax on the super-rich.** That way you could get House-style subsidy levels with Finance-style curve-bending and long-term fiscal sustainability.

* This would also arguably let the Obama administration claim not to be violating their unwise pledge to avoid raising any taxes on any individuals making less than $200,000.

** I think doing the itemized deductions thing is a better way of raising taxes on the rich, but congress seems to hate that.