The Flawed Logic of the Cadillac Tax, Explained 

The inauguration of President Barack Obama, January 20th 2009. Dan Moore
Sep 13 2018

Next week, Congress may vote on whether to further delay the ACA’s tax on high-cost plans (aka the Cadillac tax). While further delay would be welcome, Mercer and many employer groups, including The Alliance to Fight the 40, a broad coalition of which Mercer is a member, continue to urge full repeal of the tax. We and our allies also oppose possible proposals to replace it with a cap on employees’ tax exclusion for employer-provided health coverage. While that idea isn’t in play now, it has been in the past and will be in the future, and we thought the imminent House vote provides a good opportunity to remind readers why taxing employee health benefits is a bad idea.

The tax-favored treatment of employee health benefits remains a popular target for economists and policymakers who believe it is driving the high cost of healthcare in the US. The argument goes like this: Because employers and employees pay for health coverage with tax-free dollars, employers are not motivated to control their spending on health benefit cost. They act to maximize, the argument goes, the tax benefit by offering “overly generous” health coverage as a cheaper form of compensation. Then, because these rich health plans cover so much of the cost of care, employees are encouraged by the lack of financial consequences to over-utilize healthcare and to not consider price in their choice of provider -- which in turn contributes (to an unspecified extent) to the high and rapidly rising cost of health coverage.

The assumption is that curtailing the tax incentive for employer-sponsored benefits will result in a reduction in benefits, leaving employees with a larger share of uncovered medical expenses, and this additional financial pressure on consumers would result in a more efficient healthcare market.
Based on our ongoing research and our knowledge of employer-sponsored benefit programs, we strongly disagree with this argument -- and offer a few of our own:

  1. Employer health plans today are not “overly generous”: Plan designs that share significant cost with employees are the rule, not the exception.
  2. High premiums don’t equal rich benefits: Health coverage is expensive because health care is expensive.
  3. Making consumers pay more out of pocket has limited potential to lower healthcare cost because most healthcare spending is not “shoppable,” , and decisions about healthcare utilization are strongly influenced by healthcare providers
  4. Employers aren’t acting to maximize the subsidy: Health benefit cost management has long been a business imperative for most.

While it is not clear that there is any potential benefit to the US healthcare system of scaling back its tax incentives, the potential harm is significant. Without the tax incentive, for how long could US employers – many of whom must compete in a global market against companies that bear far less financial responsibility for workers’ healthcare – continue to pay the lions’ share of the healthcare costs for 178 million Americans?

Work to reduce excessive health care costs, not tax them

Employers are working incredibly hard to slow cost growth while still ensuring employees and their families have access to high-quality care. For years, these efforts have included encouraging employees to be better healthcare consumers and to take care of their health. Employers have pioneered strategies that directly address the biggest cost drivers in the US healthcare system: the relatively small number of high-cost claims that drive a large percentage of spending, increasing unit prices resulting from marketplace consolidation, misplaced incentives, waste, inefficiency, uneven quality of care and lack of transparency. Many of these experiments have met with startling success and — if scaled and encouraged — have the potential to fundamentally improve healthcare for all Americans.

Lawmakers interested in controlling health care cost growth should turn their attention to paving the way for proven strategies that both control costs and improve quality – a win-win for all.

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