The House of Representatives voted to repeal the Affordable Care Act’s (ACA) so-called “Cadillac” excise tax on high-cost employer insurance plans. Unless the Senate takes up the repeal and passes it, the tax is set to kick in 2022.
The Cadillac tax is not just a tax to raise revenue. The tax will limit the tax benefit of providing employees with high-cost insurance benefits as opposed to taxable wages.
Employer Sponsored Insurance Exclusion
Currently, money paid into an employer-sponsored health plan is excluded from the employee’s income. The employee pays no income tax, and no payroll tax.
Employees like this benefit, of course. They are generally happy to take a significant share of their compensation as an employer health plan benefits. Where employees have leverage, they tend to negotiate high-cost health plans in exchange for somewhat lower taxable wages or salaries.
Employers are fine with the benefit too, even though the tax break goes to the employee. In a competitive labor market, the money an employer would spend for plan benefits would otherwise go to its employees as wages.
Note too that the employer sponsored insurance exclusion provides a bit of a larger overall compensation pie since the IRS is not taking a slice. That provides an opportunity for employees and employees to improve both of their respective positions by tilting compensation towards health insurance benefits. Any employer that does not have a tax efficient mix of benefits will put itself at a competitive disadvantage in a competitive labor market.
The Goals of the Cadillac Tax
The ACA framers hoped that the Cadillac tax would encourage employers to shape their compensation packages away from high-cost health plans towards a mix of lower-cost insurance and higher wage compensation.
Containing medical costs is an ACA goal. The problem with high-cost health plans from an ACA perspective is that they pour in lots of cash into the medical resources markets. That puts upward pressure on the price of medical services.
Another reason for the tax is that it would produce tax revenue for other ACA benefits. Employer sponsored health insurance benefits are not taxed to employees due to the exclusion. But wages are. The tax would tend to fall on higher income employees so the change would be progressive, the thinking goes.
The Cadillac Tax is on “Excess Benefits”
The tax would generally apply to the value of health insurance benefits over certain amounts. When it goes into effect in 2022, these amounts are projected to be over $11,000 for self-only plans, and $30, 000 for other plans. There are adjustments for older retirees and employees in high-risk jobs, among others. In general, these are among the top 5 percent or so of plans.
The Cadillac tax does not change the employer sponsored insurance exclusion. The tax is solely on the employer. Nevertheless, the Cadillac tax would take a big slice out of the overall compensation pie for employers and employees that use high-cost plans.
There would no longer be a big lump of untaxed benefit that employees could seek through trading off wages for insurance.
The Cadillac tax rate is set at about the average marginal payroll and income tax on employees. True, the tax is 40 percent and marginal tax rates on employees tends to be a lot less. However, unlike employee payroll and income taxes, the Cadillac tax is calculated on an amount that does not include the tax itself. When adjusted for that fact, the rates are similar.
For example, if the taxed excess benefit is $100, the Cadillac tax is $40. If you add the amounts, the total is $140, and $40 of $140 is 28.6 percent. For purposes of comparison, if an employee pays $40 in tax on $140 in wages, the tax rate is also 28.6 percent tax.
So if the Cadillac tax were applied like an income or payroll tax, its rate would be 28.6 percent. That rate is pretty close to the average marginal tax rate for income and payroll taxes for most employees. This is not an accident. It means that an employer whose employees are relatively well paid would no longer have an incentive to offer more generous health care benefits instead of more generous wages.
Originally, employers could not deduct the Cadillac tax but that was changed by Congress. So some of this effect is weakened for corporate employers.
If and When the Tax Goes into Effect
The Middle Class Health Benefits Tax Repeal Bill (HR 748) cleared the House on July 17 by a 419-to-6 vote. Senators would be happy to vote the tax out of existence (both employers and unions oppose it), except the Senate might not have time this session.
If the Cadillac tax is not repealed, employers can avoid the tax altogether by trimming the insurance benefit a bit. In competitive labor markets, employers would need to shift compensation to higher wages. But that would not obviously disadvantage employers since other employers would have to do the same.
Union contracts would be stickier to undo, but union negotiators will know there no longer is a tax free benefit for high-cost plans on the table.
Unless an employer insists on keeping a high-cost plan, the Cadillac tax poses more of a Human Resources puzzle than it does a serious tax issue.
By James Solheim, J.D.