Repeal of the Cadillac Tax Would Be a Strategic Mistake for Both Parties

Repeal of the Cadillac Tax Would Be a Strategic Mistake for Both Parties

On July 17th, the House voted 419 to 6 in favor of repealing the so-called “Cadillac tax.” This is the levy, enacted in the Affordable Care Act (ACA) and now scheduled to go into effect in 2022, which imposes a 40 percent excise tax on high-cost employer-sponsored insurance plans. The Senate may soon follow the House by supporting repeal too, perhaps as part of a larger package of provisions extending tax breaks that might otherwise expire.

Both parties are making strategic mistakes by supporting repeal of this tax.

For Democrats, the rush toward repeal is particularly perplexing. This is a tax that was instrumental to the passage of the ACA. The Obama administration and many House Democrats were adamant that the ACA would not only extend insurance enrollment to many millions of uninsured Americans, it would do so while also reducing the federal budget deficit over ten years and the long-term. At the time of enactment in March 2010, the Congressional Budget Office (CBO) confirmed that the bill would reduce the government’s ten-year and long-term budget deficits. The Cadillac tax was an important reason why CBO projected the law’s taxes would exceed the costs of subsidizing coverage for the uninsured.

Further, the Cadillac tax was part of the “kitchen sink” approach to cost-control promoted by Obama administration officials. The authors of the ACA claimed they were willing to include in the legislation any and all good ideas for reining in spiraling health-care costs.  President Obama was sold on the need for the tax as a cost-control device for private coverage despite the fact that he had attacked Senator John McCain in the 2008 presidential race for supporting the taxation of health benefits for “the first time ever.” CBO and other analysts expect the tax will work to control costs by encouraging companies to seek out less expensive coverage to avoid the tax (federal revenue rises when this happens because employers substitute higher cash wages, which are taxable, for untaxed fringe benefits). The president took a lot of heat for this flip-flop, but he and his advisers believed the benefits of the tax were sufficient to justify the political turbulence it would, and did, generate.

Perhaps most damaging for Democrats is what repeal will do to their fiscal credibility. Democrats have spent the past two years denouncing the $1 trillion, ten-year tax cut passed in 2017 as a reckless giveaway for corporations and upper income households.  But repeal of the Cadillac tax would also drain the Treasury, by $200 billion over ten years, according to CBO, including a $35 billion reduction in payroll taxes for the Social Security trust funds.

After ten years, the revenue loss would grow rapidly, as the authors of the ACA purposely indexed the thresholds used to trigger the Cadillac tax to consumer inflation, which is well below the rate of growth of health costs. Consequently, over time, the tax is expected to pinch more and more employer-sponsored plans, forcing firms to seek out less expensive coverage or pay the excise tax. The Committee for a Responsible Federal Budget estimates Cadillac tax repeal would increase the government’s ten-year budget deficit from 2030 to 2039 by $1 trillion.

Democrats cannot claim the benefits of repeal are confined to lower tax brackets either. According to a 2015 analysis from the Tax Policy Center, 38 percent of the benefits of repeal would go to households in the top quintile, and the average value of the tax savings for these households -- more than $1,200 annually -- would exceed the absolute value of the average tax cut for all families with incomes in the bottom four quintiles. It makes sense that repeal of the Cadillac tax would not strictly benefit the middle and lower-middle class because the absolute value of health benefits rises with wage income, as does the tax savings from excluding taxable income in a progressive rate structure.

Republicans are also undermining their long-term interests by supporting repeal. The GOP opposes government-imposed cost controls, such as extending Medicare’s payment regulations to private coverage, and the party supposedly favors market-driven discipline as an alternative. Most GOP members in Congress fail to understand that the Cadillac tax is a market-driven reform.  Currently, federal tax law confers an open-ended benefit on employer-paid premiums, which are exempt from income and payroll taxes.  The more a company spends on health benefits, the greater the tax subsidy. The result is higher-costs than would exist if the tax subsidy were limited in some way.

Beginning in the Reagan administration, Republicans have attempted periodically to impose a cap on the tax break, but have always failed. The Cadillac tax is far from a perfect solution, but it is certainly better than no limitation on the tax break at all. In most respects, the effect of the tax will be just like a more straightforward limitation on the value of exempted health benefits.  Employers, and the insurers they work with, will be forced to take up lower-cost insurance options for their workers to avoid paying the tax, which is exactly what is needed to spread more cost discipline throughout the system.

If the GOP remains complicit in jettisoning the Cadillac tax, the party will have abandoned an essential ingredient of a market-driven system, thus making it harder for the party to argue against Medicare-like cost controls.

It is natural and not surprising for political parties to be attracted to short-term political gain. Repeal of the Cadillac tax will please both employers and unions, but the long-term damage to the parties’ agendas will be significant.  Republicans won’t soon let Democrats forget their votes for a massive, unfinanced tax cut, and Democrats will correctly accuse of Republicans of having no meaningful alternative to government-imposed cost controls.

James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.

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