Committee for a Responsible Federal Budget
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Let the Cadillac Tax Drive...Down Deficits and Health Care Spending

Apr 29, 2015 | Health Care| Taxes

A group of House Democrats introduced a bill yesterday to repeal the tax on high-cost health insurance plans, commonly known as the "Cadillac tax," set to take effect in 2018. The repeal joins a similar House Republican bill released back in February. Needless to say, repealing the tax would be very expensive - CBO has estimated the tax raises $87 billion through 2025 while raising growing amounts over time - and likely counter-productive to health care cost control efforts. Importantly, the tax already seems to be having clear effects on the design of employer-provided health plans and has shown itself to be an important tool to slow private health spending growth (and may be playing a role in the recent slowdown). At the very least, lawmakers should plan to offset the lost revenue from repeal, but they should focus on policies that can also bend the health care cost curve.

The Cadillac tax is a 40 percent excise tax on employer-provided health insurance plan premiums that exceed $10,200 for individuals and $27,500 for families. Those thresholds are adjusted for inflation in future years so they would provide tighter limits over time since health care costs have almost always grown faster than inflation. As a result, it will raise growing amounts of revenue over time.

The tax is an indirect way of chipping away at the largest tax expenditure in the code: the exclusion for employer-paid health insurance premiums. According to the Office of Management and Budget, this tax break will cost $206 billion in income tax revenue in 2015 and nearly $2.7 trillion over the next ten years (in addition to $1.6 trillion of foregone payroll tax revenue). And by encouraging employees to take their compensation in the form of more generous health benefits rather than taxable income, the exclusion drives up health care spending.

The effort to repeal the Cadillac tax would therefore not only make the budget worse, but also likely increase national health care spending. Additionally, repealing the Cadillac tax could undercut real wage growth, which has been consistently dampened by the fast-growing cost of employer-provided health insurance.

Repealing the tax is a step in the wrong direction; if lawmakers want to pursue reform, they could choose to further limit the subsidy for more expensive insurance plans. CBO estimated in 2013 that replacing the excise tax with a direct limit on the health exclusion set at the median premium would reduce deficits by $537 billion over ten years. With this policy, employers' contributions to premiums that exceeded the median amount would be subject to income and payroll taxes.

If lawmakers would rather do away with the Cadillac tax, though, they should focus on long-term savings that help bend the cost curve, whether they are delivery system reforms, cost-sharing reforms, or other efficiencies. Clean repeal would make getting both the budget and the health care system under control much more difficult.