Accelerate and Modify the Excise Tax on High-Cost Health Care Coverage

Although employer-paid premiums for health insurance are part of many employees' total compensation, those premiums are generally exempt from individual income taxes and payroll taxes. Employees at firms offering "cafeteria plans"--plans that allow employees to choose between taxable cash wages and nontaxable fringe benefits--can pay their share of premiums for employment- based health insurance with pretax earnings. In addition, contributions to certain other types of employee accounts, which can be used to pay for many health care costs not covered by insurance, may be exempt from income and payroll taxes. Those include employers' contributions to health reimbursement accounts (HRAs), employees' contributions to flexible spending accounts (FSAs), and employers' and employees' contributions to health savings accounts (HSAs).

Starting in 2018, an excise tax will be imposed on employment-based health care coverage if the total value of that coverage--including employers' and employees' contributions for health insurance and contributions made through HRAs, FSAs, or HSAs for other health care costs--exceeds a certain threshold. The tax will be equal to 40 percent of the difference between that total value and the threshold. In 2018, the annual threshold will be $27,500 for family coverage and $10,200 for individual coverage (which could be adjusted upward to reflect faster-than-expected growth in health care costs between 2010 and 2018). In 2019, the thresholds will change in accordance with the rate of growth in the consumer price index for all urban consumers (CPI-U) plus 1 percentage point. In 2020 and subsequent years, the thresholds will be indexed solely on the basis of the CPI-U. Higher thresholds will apply to retirees between the ages of 55 and 64 and to workers engaged in certain high-risk professions. Employees participating in union- sponsored plans will be subject only to the family thresholds. Finally, in determining the amount of the tax, employers will be allowed to adjust the cost of health insurance coverage if the distribution of their workforce by age and gender differs from that of a national risk pool.

Under this option, implementation of the excise tax would be accelerated and the thresholds would be lowered. In 2014, the 40 percent excise tax would apply to qualifying contributions that together exceeded $21,000 a year for family coverage and $8,200 for individual coverage. Beginning in 2015, the thresholds--which are based on the 80th percentile for health insurance premiums paid by or through employers--would be indexed for inflation using the CPI-U. Similar to the provisions of current law, the thresholds would be 10 percent higher for retirees ages 55 to 64 and for workers in designated high-risk professions; however, the other adjustments provided under current law would be eliminated. The option would increase revenues from income and payroll taxes by a total of $100 billion over the 2012-2016 period and by $310 billion over the 2012-2021 period.

As is the case under current law, the modified excise tax would increase revenues in two ways. First, for employment- based plans that remained above the thresholds, it would generate additional excise tax revenues. Second, many individuals and employers would probably respond to the presence of the excise tax by shifting to lower-cost insurance plans--plans with premiums below the tax threshold--to avoid paying the excise tax. As a result, total payments of health insurance premiums for those individuals would be less than they would have been in the absence of the tax. Because total compensation paid by employers would not be affected over the long term, lower expenditures for health insurance would mean higher taxable wages for employees and, consequently, higher revenues from income and payroll taxes.1

An argument in support of this option is that it could dampen health care spending and thus restrain the growth of health care costs. Many analysts maintain that the tax preference for employment-based health insurance distorts the markets for health insurance and health care. That tax preference provides incentives for health insurance plans to cover routine expenses as well as large, unexpected costs because routine charges are subsidized (through the tax exclusion) only if they are paid for through an insurance plan (or other type of tax-favored health plan, such as an FSA). Under this option, more employees and their employers would have an incentive to buy less-expensive health insurance and to reduce contributions to FSAs and other tax-favored plans for health care spending--which could reduce upward pressure on costs for health care and encourage greater use of cost- effective types of care. Those incentives would also grow under current law but would be greater under this option because the tax would start sooner and would apply to a larger share of employment-based plans. Another argument for this option is that it would simplify the computation of the excise tax by eliminating adjustments for the age and gender of a firm's workforce.

An argument against this option is that it would probably increase the financial burden on people with substantial health problems. Employers might seek to avoid the tax by shifting to plans that have lower premiums and higher cost-sharing requirements, which would increase out-ofpocket costs for those workers, and the dependents of those workers, who use more services. In some cases, those higher cost-sharing requirements might lead enrollees to forgo care that would be beneficial to their health. Another argument against this option is that more firms would be subject to the tax simply because they had less- healthy workers or because they operated in an area with above-average costs for health care. In addition, by eliminating the adjustment for age, the option would make some firms liable for the tax if they had an older-thanaverage workforce.