Capping the deductibility of employer health insurance

Health Plan Week (via AIS) has a good summary of the debate over whether to tax health benefits provided by employers. My position, which I’ll lay out a little later, is to cap deductibility rather than  eliminate it.

The article says health insurers, brokers and agents oppose taxing employer health benefits. That’s hardly a surprise since it will increase the effective price of what they sell. The opinions of academic experts are more mixed: some agree with the insurers, others think the impact would be modest, and some believe taxation would even strengthen the employer-based system by increasingly the predictability of costs.

This was a major point of difference between McCain and Obama in the general election. McCain left himself vulnerable with a wild proposal that would have gutted the employer-based system and dramatically increased the number of uninsured. As I wrote in September (Obama v. McCain on health care. Part 4: Premium subsidies and tax changes)

A centerpiece of McCain’s program is to eliminate the tax deduction for employer-paid health insurance and replace it with a tax credit to individuals and families. He’d also provide some additional subsidies to lower-income people, especially to those whose pre-existing conditions make insurance unaffordable.

As McCain points out, employer-deductibility of health insurance costs is unfair to those who lack employer coverage. The problem with eliminating such coverage is that it will erode employer-sponsored insurance and increase the number of uninsured. Meanwhile the tax credit won’t be high enough to pay for health insurance, so many employees who lose their health insurance are going to be stuck. That’s especially true for people with pre-existing conditions, who benefit today from being part of larger risk pools thanks to their employers. Overall inefficiency will rise, too because administrative expenses for individual plans are higher than those for large groups.

What I’d like to see instead is a cap on deductibility, preferably not indexed to inflation at all or indexed at a low rate. That would correct the unfairness over time without causing employers to dump health insurance. It would also provide an incentive for health plans to come up with insurance products that stay below the cap –perhaps containing costs as they do so.

After assessing other details of the plans, I concluded:

Obama’s plan would be better than McCain’s if enacted as described, because it would reduce the number of uninsured while McCain’s plan would have the opposite effect. However if McCain’s proposal led to a cap on employer deductibility as a compromise –which seems likely– I’d favor it.

I think it’s reasonable to expect caps on deductibility. Something set 10 to 15 percent above the more expensive plans on the market would be a good place to start, because it would give companies and insurers a couple of years to figure out how to respond. After that I would only raise the limit slowly.

John McCain may have done us a favor by raising the issue.

April 17, 2009

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