Administration's FSA Change Adds to Debt

The Obama Administration made an administrative change today to rules regarding Flexible Spending Accounts (FSAs) that could cost taxpayers hundreds of millions or even billions of dollars over the next 10 years. The rule change permits employers to allow employees to now roll over up to $500 of unused funds from year to year, in contrast to the "use it or lose it" rule that previously prevailed, which was intended to prevent people from sheltering income in FSAs even if they had no intent of using the money that year.

Our recent Tax Break-Down on FSAs took an in depth look. Only some employers offer them, but contributions to FSAs avoid taxation and are used for medical expenses that are not covered by insurance or dependent care. The Affordable Care Act reduced the maximum amount that could be contributed to FSAs from $5,000 to $2,500 starting this year. That change apparently prompted the Administration to make this rule change, since the tax benefits of FSAs have been reduced significantly.

Still, the change does not come without a cost. Last year, CBO scored a bill with a similar but more expansive policy as costing $4 billion over ten years, with $3 billion coming from income taxes and $1 billion from payroll taxes. Our FSA blog shows that allowing unlimited rollovers would cost $10 billion. Repealing FSAs entirely would save $60 billion over ten years.

Proponents of FSAs argue that they strengthen federal support for health care by providing more complete insurance coverage, and treating contributions as pre-tax dollars puts their treatment in line with other fringe benefits. Opponents of FSAs, however, highlight that the subsidy is regressive since its tax benefit depends on a person's tax rate, and that they encourage higher and perhaps wasteful health care spending. On the latter point, this change would have offsetting effects -- people would contribute more to FSAs, but it would limit the amount of wasteful spending at the end of the year to draw down their funds -- but it would likely on net increase health care utilization. Most major bipartisan fiscal proposals, such as Simpson-Bowles and Domenici-Rivlin, would eliminate the tax-preferred status of FSAs altogether.