Thanks to an accident of history, the U.S. tax code treats employee health benefits differently from cash wages. The “tax exclusion” for employer‐sponsored health insurance shields workers from having to pay income or payroll taxes on compensation they receive in the form of health benefits.
Economists hate the tax exclusion. It has done enormous harm to workers, patients, and overall economic productivity. It has literally ruined lives. Eliminating that tax differential may be the single most important thing Congress can do to make health care better, more affordable, and more secure.
At the same time it harms workers, however, the exclusion benefits powerful interest groups. It gives large employers and unions an advantage over their competitors. It compels workers to channel $1.3 trillion annually to human-resources professionals, health insurance companies, and health care providers. It penalizes workers if they attempt to limit that spending. Those groups denounce any effort at reform. It doesn’t help that every reform attempt to date would have raised taxes on significant numbers of workers. Finally, policy wonks obstruct reform by describing the exclusion in ways that hide how it works, how it harms workers, and the benefits of reform.
Every president since Ronald Reagan has tried to limit or eliminate the exclusion. All have failed.
Today, the Cato Institute releases a new study, “End the Tax Exclusion for Employer‐Sponsored Health Insurance: Return $1 Trillion to the Workers Who Earned It” that aims to improve the way policymakers discuss the exclusion so they can limit and ultimately eliminate it.
The study explains:
- The exclusion uses coercion to deny workers control over more than $1 trillion of their earnings each year.
- Though the exclusion reduces workers’ tax liabilities, it is not a straightforward tax break. It imposes conditions whose costs are so high, many workers turn it down.
- The exclusion is the functional equivalent of a mandate to purchase health insurance. As with an individual mandate, taxpayers must either enroll in the type of health insurance the government favors or pay more money to the government.
- Employer-sponsored health insurance is therefore not voluntary or a free-market system. It is a compulsory system in which workers must participate on pain of higher taxes (and criminal penalties if they fail to pay those higher taxes).
- The U.S. tax code threatens workers with $352 billion in penalties each year unless they allow employers to control $1 trillion of their earnings and pay a further $327 billion directly to enroll in health insurance plans that their employers choose, control, and revoke upon separation.
- The exclusion is the principal reason the United States ranks 9th among advanced nations in terms of compulsory health spending as a share of overall health spending and first in terms of compulsory health spending per capita and as a share of GDP.
- The best politically feasible way to reform the exclusion is to give workers immediate control of the $1 trillion of their earnings that employers currently control by expanding tax-free health savings accounts (HSAs).
- Reforming the exclusion with “large” HSAs would return to workers a larger share of the economy than the 1981 Reagan tax cuts. (See Figure 13, below.)
The United States will not have a consumer‐centered health sector until Congress lets workers control the $1.3 trillion of their earnings that the exclusion compels them to let their employers control.
