Tax Analysts Blog

Is the Exclusion for Employer-Provided Healthcare Outdated?

Posted on Aug 5, 2013
The largest tax expenditure is not the mortgage interest deduction, accelerated depreciation, or even the capital gains preference. It is the exclusion of employer-provided health insurance from income. Treasury estimates that the exclusion costs the federal government $163 billion a year, almost as much as the mortgage interest deduction and accelerated depreciation combined. But the exclusion is a critical component to the United States’ disjointed healthcare system, and while eliminating it might allow for steep cuts to individual tax rates, in the absence of universal healthcare it might worsen the nation’s insurance gap.

The Tax Foundation makes a strong case for eliminating the exclusion and using the revenue for an across-the-board tax cut. A straight repeal of the employer exclusion would reduce GDP by $107 billion, cost 519,000 jobs, and lower hourly wages by 0.3 percent, according to the foundation’s case study. However, if the repeal is used for a nearly 15 percent cut in individual taxes, it would boost GDP by $125 billion, raise $30 billion in revenue (using dynamic scoring), create 826,000 jobs, and increase hourly wages by 0.1 percent. It sounds very rosy.

The foundation backs up its position by using general economic arguments for repeal. Like many others, it claims that the exclusion distorts compensation and encourages an overconsumption of healthcare. It forces workers to remain at their jobs longer than they might otherwise and raises the price of healthcare. The Tax Foundation’s model makes it clear that if Congress wants to streamline the tax code, the best choice is to trade the employer exclusion for lower individual rates.

Of course, lower tax rates are the Tax Foundation’s solution to almost anything, so it’s right to be skeptical of that optimistic forecast. A working paper by Jonathan Gruber of the National Bureau of Economic Research agrees with the foundation’s conclusion, but places more emphasis on the disadvantages of repeal. According to Gruber, repealing the exclusion would add 11 million more people to the rolls of the uninsured. Gruber's numbers show that 15 million people would lose their employer-sponsored coverage if the exclusion were eliminated, but that 4 million would move to government insurance programs or find non-group insurance. He cautions that if the government considers full repeal, it would need to be coupled with other programs to increase the availability or affordability of health insurance.

And that’s where the real problem with eliminating the exclusion arises. As the debate over Obamacare showed, lawmakers simply aren’t ready or willing to consider other alternatives. Not only did President Obama fail to even open with a proposal for universal healthcare, but the watered-down public option that was in initial talks failed to attract Democratic (much less Republican) support. What other programs could be used to encourage people to buy health insurance with the money saved by a tax cut coupled with repeal of the exclusion? Certainly, something like an individual mandate might force taxpayers to spend their tax savings on insurance, but wouldn’t the mandate continue to encourage overconsumption of insurance? And wouldn’t individuals receive far less favorable terms when they are bargaining alone and not as part of employer-pooled groups?

The exclusion for employer-provided insurance might be costly, regressive, and inefficient. But until policymakers realistically consider alternatives that lower the cost of health insurance and allow individuals to bargain as a larger unit (say, the entire country), keeping the exclusion is probably better for the public than repealing it -- even if repeal is coupled with a broad tax cut.

Read Comments (1)

David BrunoriAug 5, 2013

Jeremy, most tax expenditures involve special interests who will fight like heck
to protect them. Excellent prognosis of the debate over the health care
exclusion. This tax expenditure is not only bigger than the rest, its repeal is
fraught with bigger complications.

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