The Illegal IRS Rule to Increase Taxes & Spending under ObamaCare

August 2, 2012 • Testimony
By Michael F. Cannon and Jonathan H. Adler

Mr. Chairman and members of the Committee, thank you for the opportunity to present our views on the Internal Revenue Service’s final rule concerning “premium‐​assistance tax credits” under the Patient Protection and Affordable Care Act. It is our contention that this rule exceeds the IRS’s statutory authority under the PPACA and is illegal.

Contrary to the clear language of the statute and congressional intent, this rule issues tax credits in health insurance “exchanges” established by the federal government. It thus triggers a $2,000-per-employee tax on employers and appropriates billions of dollars to private health insurance companies in states with a federal Exchange, also contrary to the clear language of the statute and congressional intent. Since those illegal expenditures will exceed the revenues raised by the illegal tax on employers, this rule also increases the federal deficit by potentially hundreds of billions of dollars, again contrary to the clear language of the statute and congressional intent.

The rule is therefore illegal. It lacks any statutory authority. It is contrary to both the clear language of the PPACA and congressional intent. It cannot be justified on other legal grounds.

On balance, this rule is a large net tax increase. For every $2 of unauthorized tax reduction, it imposes $1 of unauthorized taxes on employers, and commits taxpayers to pay for $8 of unauthorized subsidies to private insurance companies. Because this rule imposes an illegal tax on employers and obligates taxpayers to pay for illegal appropriations, it is quite literally taxation without representation.

Three remedies exist. The IRS should rescind this rule before it takes effect in 2014. Alternatively, Congress and the president could stop it with a resolution of disapproval under the Congressional Review Act. Finally, since this rule imposes an illegal tax on employers in states that opt not to create a health insurance “exchange,” those employers and possibly those states could file suit to block this rule in federal court.

Requiring the IRS to operate within its statutory authority will not increase health insurance costs by a single penny. It will merely prevent the IRS from unlawfully shifting those costs to taxpayers.

In a paper forthcoming in Health Matrix, a health law journal, we show that the IRS rule finds no support in either the statute or its legislative history.1 We summarize our findings below.


On March 23, 2010, President Barack Obama signed the Patient Protection and Affordable Care Act. A central objective of the PPACA is to prevail upon states to establish health insurance “exchanges” through which millions of Americans would purchase federally regulated and subsidized health plans.

The PPACA’s authors included multiple provisions designed to encourage states to establish Exchanges. Section 1311 commands that each state “shall” create an Exchange.2 The Act gives the Secretary of Health and Human Services the authority to make unlimited grants to states to assist them with start‐​up costs.3 The Act imposes a “maintenance of effort” requirement on each state’s Medicaid program that lifts only when a state establishes a health insurance Exchange.4 Section 1321 directs the Secretary to establish and operate Exchanges in states that fail to create one.5

Consistent with these provisions, the Act authorizes the Secretary of the Treasury to issue refundable “premium assistance tax credits” through Exchanges “established by a state under Section 1311.“6 There is no parallel language authorizing tax credits through Exchanges established by the federal government under Section 1321. During congressional consideration, the Act’s lead author, Senate Finance Committee chairman Max Baucus (D-MT), confirmed this asymmetry was intentional: the bill “conditions” tax credits on states establishing an Exchange.7

Both the text of the statute and Congress’ intent are thus crystal clear. The Act authorizes tax credits only in Exchanges “established by a state under Section 1311,” and withholds tax credits in states that do not establish an Exchange. The section of the law that authorizes tax credits uses or refers to that restrictive language no less than six times. The remainder of the statute supports the plain meaning of that restriction, and there is nothing in the statute that conflicts with it. The only statement anyone has found in the legislative history on this point comes from Sen. Baucus, the Act’s chief sponsor, who confirmed this was by design. The incentive that this limitation produces is consistent with numerous other incentives that Congress created to motivate states to establish Exchanges.

Since the PPACA ties additional “cost‐​sharing subsidies“8 and penalties against employers9 to these premium‐​assistance tax credits, the statute likewise restricts those features of the law to states that establish their own Exchanges.

IRS Rule Taxes & Spends Hundreds of Billions of Dollars without Authorization

On May 23, the IRS finalized10 a proposed rule that offers premium‐​assistance tax credits through Exchanges “established under section 1311 or 1321 of the Affordable Care Act.“11 Those six characters—“or 1321”—constitute a dramatic rewriting of the statute. By issuing tax credits where Congress did not authorize them, this rule also triggers cost‐​sharing subsidies and imposes penalties on employers that Congress did not authorize.

According to the Congressional Budget Office, nearly 80 percent of the combined budgetary impact of these tax credits and subsidies is new federal spending.12

The total cost of this rule depends on how many states decline to establish Exchanges, a decision that many states have yet to make. In the unlikely scenario that no states establish an Exchange, Congressional Budget Office projections indicate that over the 2012–2022 period the rule’s unauthorized employer penalties would exceed $100 billion and the budgetary impact of its unauthorized tax credits and subsidies would be on the order of $1 trillion.13 Since the Obama administration estimates it may have to run Exchanges for as many as 30 states,14 the cost of the rule could easily reach hundreds of billions of dollars.

Federal law and certain executive orders demand heightened scrutiny of major regulatory actions. For example, the Congressional Review Act enables Congress to block major rules, which it defines as any rule with an anticipated annual cost or economic effect of $100 million or more.15 Yet the IRS concluded this rule would not have a significant economic effect.16

The Administration’s Defense of the Rule

The administration’s public statements about this rule have been few, and are most notable for what they do not include. The administration cites no statutory authority for this move to offer tax credits in federal Exchanges—because there is no statutory authority. It likewise cites nothing from the legislative history to support its rewriting of the statute.

Instead of identifying any statutory language to support its position, the Treasury Department has said the IRS rule is “consistent with the intent of the law and our ability to interpret and implement it,“17 when in fact it is inconsistent with both the text and the intent of the law. The Department has said “[t]he statute includes language that indicates“18 that tax credits are authorized in federal Exchanges, when in fact the statute includes no such language. The Department of Health and Human Services has written that the rule is “supported by the statute“19 without actually citing any part of the statute that supports it. Indeed, the administration has yet to identify any language in the PPACA that could plausibly support the IRS’s assertion of authority to provide for tax credits and subsidies in federal exchanges. The IRS has merely assumed this power for itself.

In promulgating the final rule, the IRS defended its position in the following manner:

The statutory language… of the Affordable Care Act support[s] the interpretation that credits are available to taxpayers who obtain coverage through a… Federally facilitated Exchange. Moreover, the relevant legislative history does not demonstrate that Congress intended to limit the premium tax credit to State Exchanges. Accordingly, the final regulations maintain the rule in the proposed regulations because it is consistent with the language, purpose, and structure of section 36B and the Affordable Care Act as a whole.20

Not only did the IRS fail to identify any statutory authority for its position, it also misrepresents the text and history of the PPACA. The statutory language directly contradicts the notion that the IRS can offer tax credits through federal Exchanges, as there is no language in the statute authorizing such actions. Despite the word “relevant,” which seems calculated to exclude any inconvenient aspects of the legislative history, that history clearly demonstrates that Congress intended to limit tax credits to state‐​created Exchanges, as we document at length in our forthcoming Health Matrix article. Finally, the rule cannot be “consistent” with a statute that it contradicts.

Other Defenders of the Rule

Some PPACA supporters outside the administration have offered a more detailed defense of the IRS rule, but their arguments do not support the IRS position.

Some claim that the IRS should be allowed to interpret the PPACA to authorize tax credits in federal Exchanges. Under the “Chevron doctrine,” courts generally defer to reasonable agency interpretations of ambiguous statutory language. Yet the relevant portions of the PPACA are crystal clear. Even the IRS rule’s most vocal defender concedes that the relevant provisions “clearly say” that tax credits are authorized only in state‐​established Exchanges.21 Thus defenders of the IRS rule have sought to find other parts of the law that conflict with that clear language in order to create an ambiguity that could trigger Chevron deference. They have focused on two passages from the statute, neither of which authorizes tax credits in federal Exchanges or conflicts with the language limiting tax credits to Exchanges established by states.

The first passage occurs in Section 1321. That section provides that if a state fails to establish an Exchange, “the Secretary shall… establish and operate such Exchange within the State.“22 Defenders of the rule claim that the words “such Exchange” refer to Exchanges established under Section 1311. Yet the statute clearly authorizes tax credits only through “an Exchange established by the State under section 1311.” Moreover, Section 1311 requires that for purposes of that section, “An Exchange shall be a governmental agency or nonprofit entity that is established by a State.“23 (Emphases added.) Finally, Sen. Baucus’ original bill contained similar language (“the Secretary shall… establish and operate the exchanges within the State,” emphasis added). Yet Baucus confirmed that tax credits were available only in states that established their own Exchanges.

The second passage is an information‐​reporting requirement that Congress added to the PPACA through the Health Care and Education Reconciliation Act of 2010 (HCERA), more commonly known as the “reconciliation” bill Congress passed immediately after the PPACA.24 That requirement directs all Exchanges, whether created by states (Section 1311) or by the federal government (Section 1321), to report information regarding each individual’s eligibility for tax credits, and the amount of any advance payment of those tax credits, to both the individual and to the Treasury Secretary.

This information‐​reporting requirement is clear and straightforward, and does not conflict with, but instead reaffirms the language limiting tax credits so state‐​created Exchanges. It refers to “the credit under this section” no less than four times. Since the credit authorized under that section—the new section 36B of the Internal Revenue Code—is limited to Exchanges “established by the state under section 1311,” this provision plainly requires federal Exchanges to report zero advance payments. Because it practically requires federal Exchanges to report to individuals the amount of the credit they would receive if their state were to establish an Exchange, and enables the Treasury Secretary to issue aggregate data on the tax credits that would be available to states that have yet to establish an Exchange, this provision serves the same goal as the language limiting tax credits to state‐​run Exchanges. Both provisions encourage states to establish an Exchange. This information‐​reporting requirement in no way conflicts with the plain meaning of the language restricting tax credits to state‐​run Exchanges.

There is simply no plausible way to argue this IRS rule is consistent with or supported by congressional intent, much less the statute. The most important indicator of congressional intent is the text of the statute itself. That text is clear. It was there for all to see before Congress approved it. It is not possible that someone who read the bill could have mistakenly thought that language authorized tax credits in federal Exchanges.

Even if—contrary to all the evidence—there had been a tacit understanding among congressional supporters that PPACA would authorize tax credits in federal Exchanges, the fact that Congress approved (and the president signed) a bill with no such authorization reveals that Congress’ actual intent was not to authorize tax credits in federal Exchanges but to enact a law without them, because the alternative was no law at all. Again, there is simply no plausible way to argue that this IRS rule is supported by the statute or congressional intent.

A Miscalculation, Not a Drafting Error

The fact that the PPACA limits tax credits, cost‐​sharing subsidies, and penalties against employers to states that establish an Exchange was not a drafting error. If it were an error at all, it was an error of miscalculation.

To insulate the PPACA against charges that it was a “federal takeover,” its authors sought to give states a large role in implementing its regulatory scheme, most notably by operating its health insurance Exchanges. To achieve that goal, they offered tax credits as an incentive for states to establish Exchanges.

The flip side of that incentive, however, is that the PPACA’s authors literally—and intentionally—gave states a veto over at least three major and essential provisions of the law. They believed, of course, the risk that states would exercise this veto was small.25 But just as they misjudged the law’s popularity, they miscalculated how states would respond.

Now that some experts estimate more than 30 states will decline to create an Exchange,26 the law’s authors no doubt regret their miscalculation. But that does not alter the clear meaning of the statute. Nor does it give the IRS license to rewrite a statute, impose a tax that Congress did not authorize, or borrow and spend money that Congress did not authorize.


The law is clear. Congress did not authorize tax credits, subsidies to private insurance companies, or penalties on employers in states with a federal Exchange. Nor did Congress grant the IRS the authority to create such credits, subsidies, and penalties, as this rule does. The Framers considered the power to tax sufficiently dangerous that the Constitution requires all revenue measures to originate in the House of Representatives, because the House is closer to the people than any other federal institution. With this rule, the IRS has put itself on a par with the Congress. It has assumed the power to rewrite a statute and alter the federal tax code.

The IRS’s duty is clear. It should withdraw this rule and issue another rule that is consistent with its statutory mandate. If the agency fails to do so, Congress and the president can rescind this rule with a resolution of disapproval under the Congressional Review Act. Alternatively, employers in states that decline to create an Exchange could immediately challenge the rule in federal court.27


1Jonathan H. Adler and Michael F. Cannon, Taxation Without Representation: The Illegal IRS Rule to Expand Tax Credits Under the PPACA, Health Matrix (forthcoming), available at: http://​papers​.ssrn​.com/​s​o​l​3​/​p​a​p​e​r​s​.​c​f​m​?​a​b​s​t​r​a​c​t​_​i​d​=​2​1​06789.
2Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1311, 124 Stat. 119, 173 (2010).
3Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1311, 124 Stat. 119, 173 (2010).
4Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 2001 (b), 124 Stat. 119, 275–276 (2010). It should be noted that there is some question whether this provision is enforceable due the Supreme Court’s decision in NFIB v. Sebelius.
5Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1321, 124 Stat. 119, 186 (2010).
6Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1401, 124 Stat.119, 213–224 (2010) (Amended by the Health Care and Education Reconciliation Act).
7Executive Committee Meeting to Consider an Original Bill Providing for Health Care Reform: Before the S. Comm. on Finance, 111th Cong. 326 (2009), available at:–861c-50959b0a8392; Video: Executive Committee Meeting to Consider an Original Bill Providing for Health Care Reform: Before the S. Comm. on Finance (C-SPAN broadcast Sept. 23, 2009), at 2:53:21,–4.
Senator Ensign: Is this bill, the underlying premise in this bill that…we are making states change their laws, their coverage laws? Aren’t we doing that? And so why would not most of the coverage rules in this bill, underlying bill, be…only in the jurisdiction of the HELP Committee and not in the jurisdiction of this committee?…On certain minimum plans, exchanges. All those coverage things are state laws…How do we have jurisdiction over changing state laws on coverage?…
The Chairman: There are conditions to participate in the Exchange.
Senator Ensign: That is right.
The Chairman: For setting up an Exchange.
Senator Ensign: These would be conditions to participate—
The Chairman: And states—an Exchange is, essentially is tax credits. Taxes are in the jurisdiction of this committee.
8Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1402, 124 Stat. 119, 223 (2010).
9Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1513, 124 Stat. 119, 253–256 (2010) (Amended by the Health Care and Education Reconciliation Act of 2010 ).
10Department of the Treasury, Internal Revenue Service, Health Insurance Premium Tax Credit, 77 Federal Register 30377 (May 23, 2012), available at:–05-23/pdf/2012–12421.pdf.
11Department of the Treasury, Internal Revenue Service, Health Insurance Premium Tax Credit, 76 Federal Register 50934 (Aug. 17, 2011), available at:–08-17/pdf/2011–20728.pdf (emphasis added).
12Congressional Budget Office, unpublished data. (Available on request from the authors.)
13Congressional Budget Office, Estimates for the Insurance Coverage Provisions of the Affordable Care Act Updated for the Recent Supreme Court Decision (2012), available at:–07-24….
14J. Lester Feder, Sebelius: Exchange funding request was anticipated, Politico Pro, Feb. 14, 2012, https://​www​.politi​co​pro​.com/​g​o​/​?​i​d​=9220 [subscription only] (“We don’t know if we’re going to be running an exchange for 15 states, or 30 states.”).
15See 5 U.S.C. § 804 (2).
16See Department of the Treasury, Internal Revenue Service, Health Insurance Premium Tax Credit, 77 Federal Register 30385 (May 23, 2012), available at:–05-23/pdf/2012–12421.pdf (“It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required”).
17Sara Hansard, Private Exchanges Could Impact Success of State Exchanges, BNA Health Insurance Report, Oct. 26, 2011.
18Letter from Douglas H. Shulman, Commissioner, Internal Revenue Service, to David P. Roe, Representative, U.S. House of Representatives (Nov. 29, 2011), http://​roe​.house​.gov/​U​p​l​o​a​d​e​d​F​i​l​e​s​/​I​R​S​_​R​e​s​p​o​n​s​e​_​t​o​_​l​e​t​t​e​r​_​o​n​_​P​P​A​C​A​_​E​x​c​h​a​n​g​e.pdf.
19Centers for Medicare and Medicaid Services, Center for Consumer Information and Insurance Oversight, State Exchange Implementation Questions and Answers 8, (November 29, 2011), available at: http://​cci​io​.cms​.gov/​r​e​s​o​u​r​c​e​s​/​f​i​l​e​s​/​F​i​l​e​s​2​/​1​1​2​8​2​0​1​1​/​e​x​c​h​a​n​g​e​_​q​_​a​n​d​_​a​.​p​d​f.pdf.
20Department of the Treasury, Internal Revenue Service, Health Insurance Premium Tax Credit, 77 Federal Register 30378 (May 23, 2012), available at:–05-23/pdf/2012–12421.pdf (Emphases added).
21Timothy S. Jost, Yes, the Federal Exchange Can Offer Premium Tax Credits, Health Reform Watch, Sept. 11, 2011, http://​www​.healthre​formwatch​.com/​2​0​1​1​/​0​9​/​1​1​/​y​e​s​-​t​h​e​-​f​e​d​e​r​a​l​-​e​x​c​h​a​n​g​e​-​c​a​n​-​o​f​f​e​r​-​p​r​e​m​i​u​m​-​t​a​x​-​c​r​e​dits/.
22Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1321, 124 Stat. 119, 186 (2010).
23Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1311 (d), 124 Stat. 119, 176 (2010).
24Health Care and Education Reconciliation Act, Pub. L. No. 111–152, Sec. 1004 (c), 124 Stat. 1029, 1035 (2010) and the Patient Protection and Affordable Care Act, Pub. L. No. 111–148, Sec. 1401, 124 Stat. 119, 219 (2010).
25Supporters of the PPACA confidently predicted all states would establish Exchanges. Prior to enactment, Secretary of Health and Human Services Kathleen Sebelius testified that states were “very eager” to create Exchanges and predicted most would do so quickly. Departments of Labor, Health and Human Services, Education, and Related Agencies Appropriations for 2011: Hearing Before the H. Comm. on Appropriations, 111th Cong. 170–171 (Mar. 10, 2010), available at: http://​www​.gpo​.gov/​f​d​s​y​s​/​p​k​g​/​C​H​R​G​-​1​1​1​h​h​r​g​5​8​2​3​3​/​p​d​f​/​C​H​R​G​-​1​1​1​h​h​r​g​5​8​2​3​3.pdf. Shortly after enactment, President Obama predicted, “by 2014, each state will set up what we’re calling a health insurance exchange.” Barack Obama, U.S. President, Remarks on Health Insurance Reform in Portland, Maine (Apr. 1, 2010), available at: http://​www​.white​house​.gov/​t​h​e​-​p​r​e​s​s​-​o​f​f​i​c​e​/​r​e​m​a​r​k​s​-​p​r​e​s​i​d​e​n​t​-​h​e​a​l​t​h​-​i​n​s​u​r​a​n​c​e​-​r​e​f​o​r​m​-​p​o​r​t​l​a​n​d​-​maine.
26Lester Feder and Jason Millman, Few States Set for Health Exchanges, Politico, May 21, 2012, http://​www​.politi​co​.com/​n​e​w​s​/​s​t​o​r​i​e​s​/​0​5​1​2​/​7​6​5​9​6​.html (“Many insurance experts and health policy consultants predict only a dozen or so states will be ready to run exchanges on their own — and a few say that projection may be too sunny”).
27In light of the Supreme Court’s ruling in NFIB v. Sebelius, a strong case can be made that the Anti‐​Injunction Act would not delay employers’ ability to establish standing to challenge the IRS rule.

About the Authors
Jonathan H. Adler