CBPP: “Excess Medical Inflation” Cap is Worse than Excise Tax

Senator Tom Carper (D-Delaware) has a proposal to replace the proposed excise tax on super-expensive insurance plans with a cap on “excess medical inflation.” The idea is to impose a tax on health insurance plans equal to 40 percent of the amount by which their annual “medical inflation” exceeds a specified target rate. What rate? Well, it starts at 6.5 percent in 2013 drops to 6.0 percent in 2014 and then down to 4.5 percent in 2019 after which it equals the annual rate of growth of premiums for the least expensive one third of health plans. In addition, the ten percent of plans that’s cheapest will be exempt from the tax.

Paul N. Van de Water of the Center for Budget and Policy Priorities is not impressed with this idea and says the Senate should stick to the existing excise tax plan.

The biggest objection mounted against Baucus’ excise tax is that it’s not egalitarian enough. Sure, most of the people who would pay it would be richer-than-average, but it would hit some middle class folks and not just the super-rich. Carper’s plan, though, does worse on this score. Consider the tale of Fatcat and Middler. Fatcat gets $30,000 a year worth of health insurance from his employer; Middler gets just $10,000. But Middler’s plan is growing at a rate of 6.5% per year whereas Fatcat’s plan is growing by just 4%. Eventually Middler will wind up with a more generous benefit than Fatcat, but that’s going to take all the way until 2061 at which point they’ll probably both be on Medicare and this will be irrelevant:


Carper’s plan would have the cheaper plan taxed at a higher rate throughout this entire period even though it’s Fatcat who’s actually getting a more lavish piece of compensation. Beyond the purely distributive problems with this approach, it has a number of odd consequences, including arguably penalizing plans for having down a good job of controlling costs in the past:

The proposal would provide no incentive for health insurance plans to take many reasonable steps to limit their costs, and it would allow plans to increase costs by adding benefits. Plans would not be able to avoid the tax by introducing certain important tools to increase efficiency, such as well-structured cost-sharing, value-based insurance design, and incentives for healthy behavior (unless such changes were offset by increases in the benefit package that hold the actuarial value of a plan constant), since these changes would not count when calculating the “medical inflation rate.” Similarly, plans could not avoid the tax by eliminating low-value benefits. In contrast, plans could add benefits with impunity and not incur the tax.

The proposal could penalize plans in low-cost areas or those that have already taken significant steps to hold down costs. These efficient, low-cost plans (including plans in areas of the country that have an economical style of medical practice) would be taxed if their growth rate was above the percentage target. Plans with a low level of costs can not always keep their cost increases low, and many low-cost areas of the country have above-average rates of increase.

The existing excise tax idea is not perfect, but it’s pretty smart. It has a progressive distributive impact, it raises an adequate level of revenue, and it creates broad incentives for more efficient use of medical resources while not arbitrarily preventing people from choosing to put a larger share of their wealth into health care services if that’s what they really want.