Oxford University Press's
Academic Insights for the Thinking World

Keep the Cadillac tax

The Obamacare “Cadillac tax” is currently scheduled to go into effect in 2018. However, last week, sixty-six members of the House of Representatives, including both Republicans and Democrats, proposed to repeal the Cadillac tax before it becomes effective.

The Cadillac tax will be imposed at a 40% rate on the cost of health care insurance, exceeding statutorily-established thresholds. Unions and many of their Democratic stalwarts, otherwise supportive of Obamacare, oppose the Cadillac tax because generous union-sponsored health care plans will trigger the tax. Many Republicans reject any kind of tax. Thus, there is a substantial possibility that Congress will follow the lead of this bi-partisan group and repeal the Cadillac tax before it goes into effect.

That would be unfortunate. We should keep—indeed we should strengthen—the Cadillac tax. U.S. health care costs increase incessantly for many reasons. Chief among these reasons is that the Internal Revenue Code encourages the unknowing consumption of employer-provided medical care by excluding the cost of such care from employees’ gross incomes. Because employees do not report the substantial medical insurance premiums paid on their behalf as income, employees never confront the cost of such premiums. The Cadillac tax is an initial, minimal effort to sensitize employees to the cost of employer-furnished medical care, and should be retained and strengthened.

The Cadillac tax is an initial, minimal effort to sensitize employees to the cost of employer-furnished medical care, and should be retained and strengthened.

Under Section 106 of the Internal Revenue Code, employees do not report the premiums paid by their employers for medical care as gross income. The decision to exclude the cost of employer-provided medical coverage from employees’ gross incomes was made quite casually, in an earlier age in which health care was a minimal burden to employers and to society as a whole.

There are many reasons why medical costs have subsequently escalated. Section 106 is among these reasons. As employers grapple with the rising costs of health care, the premiums employers pay are excluded from employees’ incomes for tax purposes. This hides the costs of employer-provided medical care from employees. Costs are never controlled when they are hidden.

Abolishing Section 106 would require all Americans to confront the cost of employer-provided health care by including such cost in their gross incomes for tax purposes. Removing Section 106 from the Internal Revenue Code would force hard decisions in the workplace about health care coverage, as employees would pay income taxes on the medical insurance premiums employers expend on their behalf. Despite the strong consensus among health care experts favoring this step, neither the Obama Administration nor Congress had the political courage to repeal Section 106 and thereby include employer-paid premiums in employees’ gross incomes. Instead, in the legislation we today denote as “Obamacare,” Congress approved the Cadillac tax and President Obama signed it into law, carefully delaying the tax’s effective date until 2018.

Compared to the repeal of Section 106, the Cadillac tax is a tepid response to the need to confront the cost of employer-provided medical care. Under the tax, the employer—or the insurance company engaged by the employer to provide health care coverage—will pay a 40% tax on “excess benefits.” In general, excess benefits subject to the 40% Cadillac tax will be annual premiums or other health care costs in excess of $10,200 for a single person’s coverage, or in excess of $27,500 for family coverage. For example, if an employer pays an insurer $11,000 in premiums in 2018 for a single employee’s medical coverage, the insurance company will pay a Cadillac Tax of $320, i.e., 40% x [$11,000 – $10,200].

Those who drafted the Cadillac tax presumed that this tax of $320 would be passed on to the employer and that the employer, in turn, would transfer this additional cost to its employees. In this indirect fashion, the Cadillac tax should sensitize employees to the high costs of their health care coverage.

It would be better, and certainly more direct, to simply include part or all of the medical premiums paid by employers in their employees’ gross incomes. This would alert the employees to the cost of their medical coverage and would impel employers and employees to confront the expense of such coverage together.

The Cadillac tax is a modest, indirect means of moving the tax law in this preferred direction. Despite its limitations, the Cadillac tax is better than the status quo which, under Section 106 of the Code, shelters all employees from confronting any of the costs of their employer-provided medical care.

In apparent recognition of the indirect, tepid nature of the Cadillac tax, the Obamacare statute also requires that each employee’s W-2 form will report to them the cost of their employer’s medical care premiums, for informational purposes only. This too, like the Cadillac tax, is a very modest measure; employees rarely focus on extraneous data that does not affect their tax liability. These purely informational reports are little more than background noise.

Some fiscal conservatives object to the Cadillac tax because they oppose taxes of any kind. However, the tax can be made revenue-neutral. In particular, the modest revenues to be raised by the Cadillac Tax can be used to make equally modest reductions to federal income tax rates. In this way, the Cadillac tax, while imposing no net burden on taxpayers as a group, would shift the tax burden to sensitize taxpayers to the significant—but today untaxed—value of their employer-provided health coverage.

It would be best to repeal Section 106 of the Code altogether and thereby require all employees to report all of the cost of their employer-provided medical coverage as income. This too could be done in a revenue-neutral fashion, using the funds raised by the abolition of Section 106 to reduce federal income tax rates.

Alternatively, Section 106—emulating the Cadillac tax—could be capped so that employees include in their respective incomes employer-provided premiums above specified thresholds. Or the Cadillac tax could be strengthened by reducing the statutory thresholds triggering the tax. This would expand the tax’s reach and thereby enlarge the number of employees alerted to the cost of their employer-provided health care.

Far from being repealed, the Cadillac tax should be kept and strengthened, serving as a modest, limited measure to begin sensitizing employees to the costs of their employer-provided health care.

Image Credit: “Spring = Tax Headache” by Swire. CC BY NC 2.0 via Flickr.

Recent Comments

  1. Jonathon

    I believe the Cadillac Tax should remain, but needs to be developed more thoroughly. Unfortunately, a more developed Cadillac Tax will prove almost impossible to administer correctly. The cost of insurance is driven by more than the benefit levels provided by the plan. The average age, average risk/health, and geography all contribute to the cost of insurance. The Cadillac Tax does not provide for a clear adjustment methodology to address these variables. This creates an inherent disadvantage for employers in high-cost geographies and those that employer older workers.

    I believe many people with employer-based health care are over-insured, but repealing Section 106 would most negatively impact the low to average wage earner. Maybe a more acceptable public policy (and complementary to ACA) would be to put benefit floors in place similar to what exists for HSA qualification. This would force employers and insurance companies to better adjust benefit levels to match inflationary pressures.

Comments are closed.