Does AHCA Make Tax Reform Easier?

Much of the news coverage on the interplay between health care and tax reform claims the failure to pass the American Health Care Act (AHCA) makes tax reform more difficult. This is not necessarily true. The relationship between the two is complicated and uncertain, and we attempt to explain it here.

Many news reports have stated that replacing the Affordable Care Act (ACA or “Obamacare”) would have made tax reform easier by reducing the revenue baseline by $1 trillion. Actually, it would have made tax reform no more than $620 billion easier – and could actually have made it as much as $260 billion harder. Moreover, none of this has anything to do with budget baselines.

1. A Lower Revenue Baseline Today Would Not Make Tomorrow’s Tax Cuts Easier

The AHCA would have cut revenue by $1 trillion through 2026, which would be more than offset by $1.15 trillion in spending reductions. Its passage would therefore have reduced total revenue in the Congressional Budget Office’s (CBO) current law baseline from $41.3 trillion through 2026 down to $40.3 trillion.

But the lower baseline would not have a direct effect on how easy or difficult tax reform would be. The cost of a tax plan is the change in revenue from the baseline – no matter what that baseline is. So for instance, the individual and corporate income tax rate cuts in the House "Better Way" plan would cost about $4.3 trillion over a decade whether the baseline is $41.3 trillion, $40.3 trillion, or something else.

2. AHCA’s Failure Will Make Tax Reform Harder IF Policymakers Want to Repeal Obamacare Taxes as Part of Tax Reform

To the extent that the AHCA’s failure makes tax reform harder, it is not because of baseline changes but because the Obamacare taxes have not been repealed as they would have been in the AHCA (where they were offset with spending cuts). If policymakers still want to repeal the Obamacare taxes, they will potentially have to identify new offsets, thus making tax reform harder. Assuming deficit neutrality or a similar deficit-change target, repealing the Obamacare taxes in tax reform would require less rate reduction, more base broadening, other revenue increases, or offsetting spending cuts.

Importantly, however, this relies on the assumption that all the Obamacare taxes will now be repealed as part of tax reform. There are many indications to the contrary, including recent comments from Speaker Paul Ryan suggesting “Obamacare taxes will stay with Obamacare.”

3. Even Then, $1 Trillion is an Overestimate

While it is correct that the AHCA would have reduced federal revenue by $1 trillion through 2026, the actual tax cuts in the legislation were much smaller. Of the AHCA’s $1 trillion revenue loss, $377 billion comes from coverage provisions rather than from reducing taxes. This includes repeal of the ACA’s mandates (which if done in isolation would actually save money by reducing subsidized coverage), replacing the ACA’s tax subsidies with new tax credits and incentives, and interactions between changes in coverage and the tax exclusion for employer-sponsored insurance (ESI).

In other words, the total universe of possible AHCA tax cuts that could appear in tax reform is just over $620 billion (not $1 trillion). Moreover, most of these cuts are specific to health care and might well not appear in tax reform.

Revenue Effects of the American Health Care Act

Source: Congressional Budget Office. Note: numbers may not add due to rounding.

*Coverage changes would reduce outlays by $1.15 trillion over the same period.

In his 2014 tax reform legislation, Ways & Means Committee Chairman Dave Camp (R-MI) cut only $20 billion of Obamacare taxes by repealing the medical device tax. Other plans have also called for repealing the 3.8 percent Net Investment Income Tax. It is also possible (but probably less likely) that tax reform (which will focus on the income tax) would repeal some of the other Obamacare taxes, most of which are payroll and excise tax changes.

Thus, the failure to pass AHCA could make tax reform harder by at most $620 billion, or more likely by only $200 billion, and perhaps even less if “Obamacare taxes…stay with Obamacare.”

4. And AHCA’s Failure Could Make Tax Reform Easier by Opening Up a Huge Budget Gimmick.

The AHCA’s failure may even make tax reform easier. (Full disclosure: we hate even writing this because we think the use of the gimmick would be terrible fiscal and economic policy.)

The AHCA tax cuts were honestly paid for with even larger reductions in spending. In tax reform, policymakers may try to avoid paying for some tax cuts by working off a “current policy” baseline that assumes certain tax cuts are already in place.

The medical device tax, health insurer tax, and Cadillac tax from Obamacare are all currently on hiatus. If policymakers assume they remain on permanent hiatus, it would allow them to cut taxes by an additional $260 billion while claiming “revenue neutrality.”

This $260 billion is on top of the nearly $410 billion in “current policy” adjustments already assumed in the “Better Way” tax plan. If not prevented, this “current policy” gimmick could blow a $670 billion hole in the budget.

One piece of good news is that one important base-broadening measure is now more likely. Policymakers may now feel they have more latitude to reform the ESI tax exclusion – a measure that would both help pay for tax reform and control health care costs – than they would have had the AHCA passed.

Tax Reform is Hard, But it Must Be Paid For

While the argument that the AHCA’s failure makes tax reform harder appears to be mostly (or at least partially) a red herring, there is no question that tax reform is hard. Tax reform can improve simplicity and fairness, promote efficiency, and grow the economy – but to do so it will have to remove tax preferences that currently benefit many households, businesses, and individuals. This is no easy task.

Yet the solution should not be to give up on tax reform in favor of a debt-financed tax cut. Failure to pay for tax reform will hurt economic growth, forgo the opportunity to promote efficiency and fairness, and add to our already damagingly high debt. Tax cuts do not pay for themselves, so policymakers must identify the policies that will.