The underlying policy problem is that employer-sponsored health insurance gets a hefty tax benefit. But as with any such policy, the inverse is that employees face a massive tax penalty if they don’t let their employers pay for and control their health insurance. That money still comes out of every employee’s earnings and is included by employers in their total compensation costs. It’s your money, but you aren’t allowed to spend it as you like. According to Cannon’s calculations, this part of the tax code effectively threatens U.S. workers with $352 billion in additional taxes if they do not let their employers control around $1 trillion of their earnings.
Employer-sponsored health insurance has long been known to have serious downsides. For one thing, it hobbles the individual market for health insurance, leaving those who need it without good options. It also has severe impacts on labor mobility and the job market, since workers risk losing their insurance coverage every time they change jobs. One study found that the exclusion reduces voluntary job turnover by 20 percent per year, Cannon notes.
This policy also distorts the incentives of the health care market. Instead of being answerable directly to consumers, health care providers must answer to insurers who in turn answer to employers. This indirect accountability has the effect of wrecking the usual give and take between consumers and providers that works so well in every other market.
In this study, Cannon catalogs a range of other negative effects. The employer-based system proved to be particularly inapt in a crisis like the pandemic, when millions of Americans lost their jobs and thus their coverage at the exact time when so many needed it.
Ending the tax exclusion for employer-provided health insurance, which is the same thing as a massive tax penalty for those who do not use such arrangements, would amount to returning control of over $1 trillion to workers rather than their employers. Cannon notes that this would amount, in effect, to a $1 trillion tax cut by ending the use of government coercion to divert money out of the pockets of the people who have earned it.
While the best reform would be to simply end the tax exclusion altogether by eliminating the underlying taxes on payroll and income, Cannon proposes several possible more modest alternatives. These include a broad tax reform to end distortionary exemptions across the board, following the principle that the tax code should be as simple as possible with the goal of raising necessary revenue, rather than a tool for social engineering and economic central planning. Short of that, Congress could at least repeal this particular exclusion.
The most politically feasible reform idea might be to expand the use of health savings accounts (HSAs), which currently provide a limited kind of tax exemption to individual health care spending outside employer-sponsored plans. For such a plan, Cannon proposes that Congress raise the limits on HSA contributions and allow health insurance to be a permitted use of HSA funds, alongside other policy changes that would in effect end the exclusive tax benefits of employer-sponsored insurance plans.
Americans do not expect employers to directly provide their employees with housing, groceries, a car, or other necessities. It’s not difficult to imagine how that would be a nightmare, radically reducing personal freedom and creating hopelessly broken markets for those goods and services. Instead, employers simply pay employees, leaving them free to spend that cash however they choose. There’s no reason it shouldn’t be the same for health insurance, freeing employees to control their own earnings and spend them as they like in a free, competitive marketplace for health insurance services.
“End the Tax Exclusion for Employer-Sponsored Health Insurance,” Cato Policy Analysis no. 928, can be found at cato.org
