Understanding the Health Insurance Excise Tax

The health care reform bill recently passed by the Senate Finance Committee relies on a $200 billion health insurance tax to help fund the costs of expanding health insurance coverage. Although there are some exceptions, the policy generally imposes a 40% excise tax on each dollar of health insurance premium beyond $8,000 for an individual or $21,000 for a family.

 

Although this tax is far from perfect (limiting the employer sponsored insurance tax exclusion directly would probably be better), it has at least two major advantages in the context of health reform: it grows faster than new health care costs and it helps to slow health care cost growth.

 

A Growing Revenue Sources

The excise tax offers a growing source of revenue. This is because the $8,000/$21,000 threshold is only indexed to 1% above inflation (CPI+1), but actual health insurance costs are projected to grow much faster. As a result, according to the Joint Committee on Taxation (JCT), the percent of premiums affected by the tax would increase from 4% in 2013 to 11% in 2019.

The importance of having a rapidly growing set of offsets in the health care bill should not be understated. Since the costs of coverage expansion itself must grow to keep pace with premium costs, they have the potential to add significantly to the deficit beyond the ten-year window. This is the case in the House bill, which relies largely on an income surtax to finance its costs.

Annual Growth of Coverage Provisions and Income Surtax in House Tri-Committee bill (billions)
Sources: Congressional Budget Office, Joint Committee on Taxation, and CRFB Calculations

The Finance bill, meanwhile, is actually projected to reduce the deficit in the second decade by between ¼ and ½ of GDP - in no small part due to revenues from the excise tax growing faster than the costs of coverage expansion.

Annual Growth of Coverage Provisions and Health Insurance Excise Tax in Senate Finance bill (billions)
Sources: Congressional Budget Office, Joint Committee on Taxation, and CRFB Calculations

 

A Potential Curve Bender

In addition to being a growing source of revenue, the excise tax could actually help to reduce overall health care costs. Currently, because compensation in the form of health insurance is untaxed, employers provide a disproportionate amount of compensation in the form of insurance - which in turn helps to drive up health care costs. By taxing high-cost insurance, though, the incentives reverse. As we explained in Evaluating Health Care Costs:

The excise tax would increase the price of high-cost insurance, leading to seek out more efficient and less generous insurance. Doing so would drive down both health care prices and utilization, slowing system-wide health care cost growth.

The Lewin Group modeled a similar (but much more aggressive) policy --- capping the health insurance tax exclusion for high earners and expensive plans --- and found that while the plan would raise $760 billion over ten years, it would also reduce national health spending by $280 billion.

 

So Where Does the Money Come From?

While the Finance Committee's excise tax has the benefits of both growing faster than the bill's costs and helping to slow health care cost growth, it is no free lunch. And although the tax is technically imposed on insurance companies, the vast majority of it will be passed along to consumers in the form of higher insurance premiums.

At that point, employers and employees will face a choice: either pay the higher premiums, or accept lower-cost insurance benefits in place of higher cash wages - which are subject to normal taxation. According to JCT's estimates, most will do the latter.

Of the $201 billion in revenue JCT estimates the excise tax will generate, only $38 billion - less than 20% - would come from the excise tax itself. The lion's share of the revenue would come from the income tax - as firms began offering higher wages in exchange for providing less generous health insurance benefits. A substantial portion of the revenue would also come from Social Security payroll taxes; this revenue would technically go into the Social Security trust funds, modestly improving the system's cash balance in the short run, but resulting in higher future benefits.

Source of Revenue from Excise Tax through 2019 (billions)

Source: Joint Committee on Taxation

*also includes impact of other on-budget taxes such as the Medicare payroll tax

The fact that most revenue from the excise tax would come as a result of higher cash wages strengthens the thesis that the excise tax could slow health care cost growth. Although cheaper insurance need not mean less health care spending, there is certainly a strong correlation between the two.

This is not to suggest that the excise tax is a perfect policy - in fact it is far from it. It is also not to suggest that the excise tax would do even nearly enough to slow health care cost growth - much more is needed.

But given its benefits, policy makers should think twice about abandoning or diluting it, unless they are willing to replace it with something better.

Breaking the tax pledge

If the excise tax raises social security revenue, doesn't that mean it is increasing taxes on people making under $100,000 a year? And isn't that a violation of Obama's tax pledge?

According to JCT's

According to JCT's distributional tables, part of the tax would, indeed, fall indirectly on those making below $250,000 a year. In 2015, according to their estimates, roughly 85% of new revenues would come out of wages or compensation for individuals making under $200,000.

 

Whether that is a violation of Obama's pledge is a political question. Technically, the tax falls on insurance companies - which could argue that it isn't. Furthermore, the administration might point to the net effect -- yes some people will face higher (indirect taxes), but many others will receive large health care subsidies from the government.

 

The more important question is whether or not President Obama should have made that pledge in the first place, and whether or not it is sustainable. We've urged his Tax Reform Task Force to Think Big -- which means not limiting themselves to such a constraint.

 

The nation is facing real debt issues. And on top of that, the tax code is in many ways broken. Giving 95% of Americans immunity from any change will make reform quite difficult.

 

The same is true, by the way, for spending. We think everything should be on the table.

Excise tax for health plans

This tax is still not clear to me on how it would affect individual families. For example, my wife and I both work for an employer who provides health insurance, we have to pick from a group of five plans but have to each pick one of plans. We each contribute our own dollars for the plans that we choose, the employer portion paid by the employer is roughly $16,000 to $17,000 for each of our plans or $32,000 to $34,000 for our plans annual premium. If this tax was part of the health bill would my wife and I be subject to an excise tax on our health plans and what in dollars would that tax be. Thank You, Jamey Gilmore

The insurance company itself

The insurance company itself pays the tax, technically. But to the extent you remained in current plans -- and the insurance company made no major change them -- this tax increase would probably result in higher premiums.

 

Hope that helps.

 

-Marc

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It is a fact that whenever

It is a fact that whenever the employers are taxed with one or the other reason they ultimately pass on the tax to the end users of their product, that are the customers. Not only in case of health insurance but always such things are observed in any field. Either they increase the costs of the products or people have to sacrifice the quality of the product. None of these options is really beneficial for country’s growth. It results in increasing the inflation to some extent. Those who are with lower income are always deprived of quality health insurance benefits due to such policies. Tax Matters Solutions

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 A fix for our health expenditure crisis needs to involve individual responsibility for maintaining a healthier lifestyle as well as limiting heroic near end of life spending. Tax Debt Relief

the excise tax concerns me

My husband works for a large manufacturing company in a rural area; it provides its employees with extraordinary benefits such as five weeks' paid vacation, top salaries of $25 an hour for hourly workers plus cost of living increases, modest annual bonuses, and generous health insurance coverage under which employees pay no premiums at all, for themselves or their families. Thus this coverage could easily be considered a "Cadillac" plan, although its beneficiaries are blue-collar workers who make, on average, about $40k per year. Although the tax is not officially targeting us as consumers of the plan, it really bothers me that the company will be punished for providing excellent-quality care at little cost to us, and that they will be forced to begin charging premiums, which will really hurt these lower-middle-income families. Thus we would be punished for having chosen to work for a company that offered excellent benefits, simply because other companies have failed to do likewise.

health insurance

The excise tax will effect anyone who draws a paycheck. It will increase every year until the program fails. If you like playing with numbers work it out. The program will start showing problems from the start. As the population increases so will the demand. If there were a copay for everyone this would help save the program. you could deduct the copay from a welfare check if the person states that they have no money. As it stands on face value the program will fail in less then fifty years. God bless you young people because the gov. won't

Reduced Health Insurance

My employer reduced my health insurance benefits and raised my preminums to avoid the surtax.  No salary raise to compensate.  This causes me and others to be subsidizing the "affordable" health care plan.

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