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.
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 2rd to 4th
quintiles) that are affected can expect to experience an increase in income tax
liability that will average from $453 for the 2nd quintile to $858
for the 4th 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.
