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It's nice to see Finance Committee Chairman Max Baucus moving towards capping the tax exclusion for employee health benefits. (As it stands, employer-offered health plans are exempt from payroll and income taxation, unlike most other forms of compensation.)

The problems with the current health-care tax exclusion are numerous and worth repeating. First, the exclusion is poorly targeted. The largest benefits go to the employees with the largest incomes, who would have the least trouble paying for healthcare on their own. Second, subsidizing the plans offered by employers increases labor market rigidity. Workers have any easier time leaving or switching jobs when they don't fear losing swanky coverage. Third, there's a lot of revenue at stake. The tax exclusion has been described as the largest single subsidy in the tax code. In 2007 it reduced federal tax collections by $246 billion.

But perhaps the biggest problem is that it gives employers and employees an incentive to offer more generous plans and consume more luxurious health services than they otherwise would. The subsidy leads to an increase in demand. The increase in demand raises the price. Health care doesn't get any less expensive.

So it's good to see Baucus moving in on these problems. That said, I have three questions/concerns about his (still evolving) plan to cap the tax exclusion. They are:

1. Capping the exclusion raises equity issues. The Washington Post says Baucus wants the cap to start at plans costing $13,000 for a family of four. But health-care premiums can vary for reasons other than the generosity of a plan. There's geography (some regions are more expensive than others), the age and health of the taxpayer, and the size of the employer in question (small firms have higher administrative costs than larger ones). If what we want to limit is the overconsumption of services, capping the tax exclusion on the basis of the premium is imperfect. (Stan Dorn of the Urban Institute had an interesting paper on this recently.)

2. Capping the exclusion raises tax-progressivity issues. There are two basic ways to cap the health-care tax exclusion. The first is to cap based on the value of the plan. This is what Baucus wants to do: Plans worth more than a certain amount will no longer be excluded from federal taxation. But you could also cap the exclusion based on the income of the employee -- ie, employees with incomes above a certain threshold would see the health benefits tax phase in and increase, much like the income tax itself.

Or better yet, you could combine the two methods. Is there any reason not to do that instead?

3. Why exclude union benefits from the cap? Reportedly, Baucus wants to do this. I understand that this might be a necessary compromise. But, as Ezra Klein points out, it's hard to see why benefits achieved through collective bargaining should be considered different, for tax purposes, from any other kind of employee benefit. (It's even more difficult to see why unionized employees of companies that are now de facto owned by the federal government should be entitled to more generous plans than other employees of the federal government.)

What am I missing?


Contemplative-looking Baucus photo from Brendan Hoffman/Getty Images

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Conor Clarke is the editor, with Michael Kinsley, of Creative Capitalism. He was previously a fellow at The Atlantic and an editor at The Guardian. More

Conor Clarke is the editor, with Michael Kinsley, of Creative Capitalism, an economics blog that was recently published in book form by Simon and Schuster. He was previously a fellow at The Atlantic and an editor at The Guardian. He is also on Twitter.
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