Want to Tax Health Benefits? Better Keep Those Exchanges Healthy
Rumors are flying this week in Washington about a possible rough draft for the Senate’s health-care “reform” bill. One surprising item is the possibility that the bill would impose a tax on the receipt of health insurance benefits. Tax geeks would call this a (partial, probably) repeal of section 106, the current provision that allows employees to exclude the value of health insurance from their taxable income. It’s a surprising route because of the enormous unpopularity of the so-called “Cadillac Tax,” now twice delayed, which when implemented will also effect a (very) slow-motion repeal of 106. Combining 106 repeal with other provisions that will weaken health exchanges and reduce protections for individuals with preexisting conditions is an especially toxic combination, and it’s worth emphasizing why.
A predictable result of taxing employer-provided health insurance is that some employers will stop providing insurance, obliging workers to seek coverage on the individual market. The standard assumption is that employers will then pay workers higher salaries, with the increase representing the amount of premium payments saved.
If so, in a world of weak marketplaces, this is potentially a very large loss for some workers. Absent regulation, individual-market policies for workers with poor health histories will be astronomically higher than the old combined worker-employer cost. That is, of course, because of adverse selection. By pooling workers together somewhat randomly, employer insurance pools greatly reduce adverse selection, allowing the actuarially fair insurance premium to be much lower. Thus, when we shift workers into the individual market, in essence what we are doing is forcing those workers to absorb the social costs of adverse selection.
If individual marketplaces look much as they do now, the social costs of adverse selection are relatively modest. Most readers here know that community rating, guaranteed issue, and the individual mandate help to ensure that even in individual markets, sick folks and healthy folks are pooled together with premiums that reflect an average of the riskiness of the whole pool. Some may not know of recent findings suggesting the importance of what are sometimes called “risk corridors.” The risk corridor is a payment from an insurer with a healthier-than-average pool to an insurer with a sicker-than-average pool. These payments in theory should discourage insurers from trying too hard to shop for healthy customers, and data suggest that in fact that seems to be happening. This means that, indeed, healthy and sick individuals are being pooled together, instead of the sick being shunted off together, where they will all pay higher premiums.
Tinkering with this web of systems that protect the individual market, in all of the many ways that the House AHCA bill does, would then make 106 repeal especially costly. We don’t know how much the Senate bill will do that, but it has been said to include “80%” of the House bill.
What about the workers who would face the lowest premiums in an unregulated marketplace — the young, male, and healthy? Conceivably, these workers could be better off under a repeal, although we have to make a series of assumptions about tax, labor economics, and psychology to get to that result. Briefly, the young dudes would expect to get more in salary than their subjective valuation of the health insurance premiums they’re losing, assuming that salary and premiums are set uniformly for everyone in similar positions at the employer. Since the young dudes were, in effect, paying some of the health insurance premiums for everyone else, they can now obtain a raise if insurance is replaced with cash.
Among other difficulties with this account, it fails to account for the tax differences. Under an exemption (section 106) regime, employers and workers split the income and payroll tax savings from excluding a portion of compensation from the tax base. The young dudes prefer cash to employer-provided insurance, making them likely closer to the margin than sicker or female workers. But we know from the fact that they accepted their employer’s job offer that their distaste for non-cash compensation is less than their share of the tax exemption. So revoking exemption necessarily leaves them worse off on net, assuming that this is really how bargaining over wages and benefits works.
It is possible to eliminate this impact on the marginal worker, but unclear that that is a desirable outcome in the present political climate. Regina Herzlinger & Barak Richman show, in a nifty new working paper, that it is possible for Congress to raise revenue by allowing workers to purchase insurance on individual markets themselves using tax-free employer premium payments. What’s undesirable about that? Well, it might ease political opposition to a Senate bill by the marginal (young dude) worker. And if the Senate bill is really 80% of the AHCA, we probably shouldn’t want to do anything to make it easier to pass, even if that thing represents a marginal improvement along one policy dimension.
