Employers can exclude an unlimited amount of employer-provided health benefits from wages when calculating payroll and income taxes. That tax exclusion is both inequitable and inefficient. It gives the biggest tax breaks to the highest earners, and causes everyone (high earners in particular) to buy excessive amounts of health coverage and health care.
In 2004, Congress created HSAs, which counteract that incentive by granting the same tax-free treatment to a limited amount of health savings. The worker owns her HSA deposits, can spend them tax-free on health care, and whatever she doesn’t spend grows tax-free. That levels the playing field between (1) employer-sponsored health insurance and (2) health savings and the direct purchase of health-care services.
Economists and others have long recommended eliminating or capping the exclusion to promote equity and efficiency. However, that by itself would be a tax increase. Therefore, caps must be accompanied by some offsetting measure, such as a reduction in tax rates, to prevent a net tax increase. And whatever Congress does to change the tax code, it is crucial that it not tilt the playing field back toward over-reliance on health coverage.
The tax reform commission’s leading proposal - Plan A - seems to fail on both these counts. According to reports, it would cap the exclusion without any offsetting measures and would tilt the playing field back toward over-reliance on health insurance.
Plan A reportedly includes three major changes affecting health care:
- It would cap the currently unlimited tax exclusion for employer-sponsored health insurance at $5,000 for those with self-only coverage and $11,500 for those with family coverage.
- Second, it would create what Tax Notes describes as “an equivalent tax break for individual policies” for those without employer-sponsored insurance.
- Third, it would roll HSAs (and other tax-preferred savings accounts) into “save for family accounts.” (Let’s call them SFFAs.) Unlike HSA contributions, SFFA contributions would be taxed.
Thus, it seems the commission’s Plan A would cap the exclusion without any offsetting measures to prevent a tax increase. What’s more, the proposal would seem to eliminate tax-free HSA contributions. The end result would be two health-related tax increases,
The impact would be severe. Projections by the Lewin Group suggest the commission’s caps would tax the health premiums of 29 percent of those with self-only coverage (11.2 million individuals) and 18.5 percent of those with family coverage (7.7 million families).
Eliminating tax-free HSA contributions would affect over one million Americans and destroy the benefits of HSAs. Since below-the-cap premiums for third-party insurance would remain untaxed, workers and employers would stick with or gravitate back toward excessive coverage.
The commission’s proposed caps would be set well above the average premium for HSA-compatible high-deductible health plans ($2,700/self-only, $7,909/family). Since only insurance premiums would be untaxed, employers and workers would have every incentive to maximize that tax break by sticking with comprehensive third-party coverage (average premiums: $4,024/self-only, $10,088/family).
An impetus behind the commission’s efforts is the need to head off growth of the alternative minimum tax (AMT). Under current law, the AMT automatically will increase taxes for millions of middle-class Americans. The commission wants to repeal the AMT - but preserve the tax revenue that it would generate. Maintaining those revenue levels requires a tax increase, and it looks as though the commission has set its sights on health insurance and HSAs.
A better way to promote efficiency and equity in health care would be to cap the exclusion, but grant workers ownership and control over every one of those health-care dollars. One proposal would do be to increase HSA contribution limits so that workers could elect to receive all their health benefits as a cash contribution into their HSA. That would allow Congress to cap the exclusion, but give workers considerably more freedom with regard to their health benefits.