American Benefits Council: Evaluating the Impact of the 40 Percent ‘Cadillac’ Tax on Plan Sponsors and Participants: Analyzing Economic Research

November 18, 2015| BBP 2015-9

Evaluating the Impact of the 40 Percent ‘Cadillac’ Tax on Plan Sponsors and Participants:

Analyzing Economic Research

Beginning in 2018, Internal Revenue Code Section 4980I – as added by the Affordable Care Act (ACA) – imposes a nondeductible excise tax on employers, health insurance issuers, and/or entities administering plan benefits if the value of applicable employer sponsored coverage exceeds a specified annual limit. This tax, commonly known as the “Cadillac Tax,” is equal to 40 percent of the aggregate value in excess of the annual limit.

Numerous recent studies have attempted to quantify the practical effect of the tax on employer-sponsored coverage and have reached different conclusions. Among the most significant findings are:

·        Under the scenarios examined, a very large percentage of workers (and their families) are enrolled in plans that will trigger the tax – even though the original intent of the 40% tax on health benefits may have been to target only “overly rich” plans.

·        Middle income workers affected by the excise tax will experience significant reductions in benefits and will bear an increased tax burden that is a greater proportion of their income than for high and low income groups.

The Council’s analysis of these studies demonstrates that the tax will almost certainly increase taxes or costs – or both – for employers and employees. The Council strongly recommends lawmakers acknowledge these projections and act immediately to repeal the tax.

                                                

Background

This tax was included in the ACA to raise revenue to pay for other provisions and dampen the rate of increase in health care spending by curtailing “overly generous” health coverage. In so doing, the authors sought to “bend the cost curve” downward.

The tax is currently estimated by the Congressional Budget Office (CBO) to generate $91 billion in revenues over the next ten years. Roughly three-fourths of this revenue is anticipated to come not from the tax itself but from employers reducing health care expenditures (currently excluded from payroll and income taxes), and correspondingly increasing taxable compensation by an equivalent amount, thereby generating higher income tax revenues. (This is a controversial assumption that comports with standard economic theory and a variety of econometric studies, but contrasts with the expectations of many employers.) The other one-fourth of the assumed revenue would be attributable to plan sponsors maintaining benefit levels and triggering and paying the tax.

Pursuing cost containment through a tax imposed on insurers and self-insured plans was a political compromise that enabled the sponsors of the legislation to achieve their dual objectives (raising funds and “bending the cost curve”) without explicitly altering the current tax treatment of employee benefits. Sponsors are theoretically free to continue to provide tax exempt benefits at a level of their choice, with the tax paid by the entity underwriting the coverage. In reality (as anticipated by the revenue estimates and recent studies) the provision will effectively impose a cap on the health benefits provided by employers, as most employers redesign their plans, to the extent possible, to avoid the tax.

To better understand the impact of the excise tax it is important to evaluate (1) the number of employers expected to be affected and (2) the distributional impact on individuals at varying income levels. These are the subject of two recently released analyses.

Kaiser Family Foundation: How Many Employers Will Be Affected?

In an August 2015 Issue Brief, How Many Employers Could Be Affected by the Cadillac Plan Tax, the Kaiser Family Foundation (KFF) used the 2015 Kaiser/HRET Employer Health Benefits Survey (EHBS) to look at self-only plan costs and estimate the proportion of employers with costs that would exceed the thresholds between 2018 and 2028. The paper considers two scenarios: (1) imposing the tax on the aggregate cost of premiums, Health Savings Accounts (HSAs) and Heath Reimbursement Accounts (HRAs); and (2) including Flexible Spending Accounts (FSAs) in the applicable health benefit costs.

The analysis finds that for the lower applicable set of costs (premiums, HSA and HRA), 16 percent of employers would have at least one plan that would be subject to the tax in 2018, increasing to 36 percent by 2028. Including FSAs in the applicable costs would raise the share of affected employers to 26 percent in 2018 and 42 percent by 2028. Among firms with more than 200 workers the proportion with a plan above the thresholds is estimated to be 46 percent in 2018 increasing to 68 percent by 2028.

Share of Employers with At Least One Plan Hitting Threshold
Year	Self-only coverage threshold	Scenario 1: Premium + HSA + HRA	Scenario 2: Premium + HSA + HRA + FSA	Premium + HSA + HRA + FSA, Companies with 200+ workers
2018	$10,200	16%	26%	46%
2023	$11,800	22%	30%	56%
2028	$13,500	36%	42%	68%

It is important to remember that these are the number of employers offering health benefits that are estimated to have at least one of their plans affected by the tax. The proportion of workers will be different and could be either more or less than these numbers depending on the frame of reference. Among those working for firms now offering benefits the proportion could be higher because larger employers typically provide more generous benefits (as evidenced by the above-referenced higher number of plans sponsored by larger employers that will trigger the tax).

Urban Institute: Cadillac Tax vs. Capping the Exclusion

The second analysis provides an evaluation of the distributional outcomes that are projected to result from two potential policy approaches for achieving cost containment and raising revenue.

The Urban Institute’s October 2015 study, The ACA’s“Cadillac Tax Versus a Cap on the Tax Exclusion of Employer-Based HealthBenefits: Is This a Battle Worth Fighting?, uses simulations to evaluate the impact on various income segments with respect to both the 40 percent tax and the theoretical imposition of a cap on the tax exclusion of employer sponsored health benefits at the same thresholds.

This study finds the impact of the tax will be unevenly felt across the income distribution in complicated ways. If employers reduce benefits to avoid the tax and adjust cash compensation upward in an amount equal to the reduction in benefits, the analysis concludes that most of the increased tax revenue (about two-thirds) will come from the top 40 percent of the income distribution. This is largely because this group has much higher income tax rates that will result in much higher revenues from an equivalent amount of shift in compensation from health benefits to taxable income. The simulations indicate that in 2020, among those in the middle 60 percent of the income distribution (the 2^rd to 4^th quintiles) that are affected can expect to experience an increase in income tax liability that will average from $453 for the 2^nd quintile to $858 for the 4^th quintile. These tax increases are the net value of the shift in the compensation package from health benefits to taxable income, indicating that the expected loss in health benefits will be several times these values – although the study does not report these numbers.

The evaluation of an alternative scenario in which sponsors chose to retain benefit levels and therefore incur and pay the tax indicates a somewhat more regressive distribution of costs with about two-thirds of the tax-related costs falling on the middle 60 percent of the income distribution.

Additionally, the imposition of a direct cap on the tax exclusion would result in the distribution of costs essentially equivalent to the outcomes projected for the tax. Thus the Urban Institute authors assert that capping the exclusion represents a better policy because it would have more direct and certain distributional effects while achieving the same cost-containment and revenue outcomes.

In considering analysis about the distributional effects of the 40 percent tax, it is important to bear in mind that this study and an earlierevaluation of the tax undertaken by the Tax Policy Center (a research entity jointly managed by the Urban Institute and the Brookings Institution) indicate that the proportion of the tax imposed on middle-income groups exceeds their current share of income and federal tax liability and will therefore increase their relative tax burden.

Specifically, the studies estimate that if employers reduce health benefits to remain below the excise tax thresholds, in the first year nearly 25 percent of all new taxes resulting from the provision will fall on the middle one-fifth of taxpayers, a group that receives only about 14 percent of income and pays 11 to 12 percent of federal taxes according to the most recent CBO analysis.

Conclusion

Proponents of the 40 percent tax may point to the CBO estimate and economic theory to support the assertion that the tax will “bend” the health care “cost curve” while raising a significant amount of revenue. But these two studies illustrate the more immediate and widespread threats to middle class workers posed by the tax.

The tax is likely to hit a significant percentage of employers as soon as it goes into effect, with that percentage rapidly growing as the years pass. Although much of the dollar value of the tax will fall on higher income groups, this is largely due to their higher income tax rates. As the studies show, the tax will result in the loss of thousands of dollars of employer sponsored health benefits and increased taxes for many workers at all income levels leaving them measurably worse off. The effect on various income groups will be unpredictable but likely to be disproportionately felt by those with moderate incomes.

No matter what approach Congress chooses going forward to address health care costs, the strategy should begin with repeal of the 40 percent tax.

Coverage for 175 Million Americans at Risk

As seen in today's California Healthline, a great piece from Katy Spangler with the American Benefits Council:

Coverage for 175 Million Americans at Risk

While the Cadillac tax sounds like it applies to a small handful of individuals with luxurious health coverage, the truth is the health care that 175 million Americans like and want to keep is at risk because of this tax. Hardest hit will be retirees, low- and moderate-income families, public sector employees, small businesses and the self-employed. The tax must be repealed.

The Cadillac tax is a 40% non-deductible excise tax on the value of employer-sponsored health coverage that exceeds certain benefit thresholds -- initially, $10,200 for self-only coverage and $27,500 for family coverage in 2018.

The tax was clumsily constructed and thus penalizes employers for factors that are completely out of their control, impacting employers that have a higher number of disabled workers, unusual cases of high-cost cancer, premature babies or larger families, for example. Employers with locations in high-cost areas or in specific industries, such as manufacturing or law enforcement, are also unequally targeted by the 40% tax. Every year an increasing number of moderate health plans will be subject to the tax because it is indexed to the consumer price index, which is lower than health care inflation. In fact, 82% of employers believe their plans will be affected by the tax within the first five years of implementation.

It is urgent that Congress repeal the 40% tax as employers are already taking steps to avoid it by cutting benefits and changing plan designs. A recent study found employers are increasing deductibles and implementing other cost-sharing programs right now, in 2015, to avoid being on a trajectory to trigger the tax when it goes into effect in 2018.

Supporters of the tax argue it is necessary to drive down health care costs -- but the reality is the tax does nothing to make health care more affordable. It is not decreasing the cost of hip or knee replacements or prescription drugs. It is merely forcing employers to shift costs to employees in the form of higher deductibles and copays. 

Thankfully, a majority of members of Congress agree the tax should be eliminated and have cosponsored bills to repeal the tax. This bipartisan group recognizes the harmful impact the tax is already having and will continue to have on their constituents. Congress can't wait -- the time to repeal the tax is now.