Business

The Bulletproof Case for Ending the Employer Insurance Subsidy

By Derek Thompson
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In our Flashcard series, The Atlantic aims to decode the concepts and terms readers encounter every day but seldom see explained. Today's installment: the proposals to reform the tax-free status of employer-provided health insurance, the most expensive tax giveaway in the country.

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The News

Proposals to reduce the deficit are zipping around Washington and cable television, as politicians struggle to find acceptable solutions to limit America's addiction to debt. The plans have dramatic differences, but most of them agree on one major reform that the health care overhaul is already scheduled to tackle in 2018: the tax subsidy for employer-sponsored health insurance. What does this particular tax giveaway do; and if everybody agrees that we should get rid of it, why haven't we?

The Gist

Today, 160 million people, or two-thirds of the population under 65, get health care through their employers. Offices are logical places to get insurance for two reasons. First, a diverse group of employees helps insurers to "pool risk," since employees provide insurers with a diverse pool of cheap, healthy people and more expensive, more needy individuals, as Paul Van de Water notes..

The second reason why offices dominate the insurance scene is that the government basically pays employers to offer health care. Your company wages are taxed; your company health care is not. Economists call that a "tax subsidy."

This is good news and bad news for workers like you. The good news is that this subsidy saves us money on health spending and makes it cheaper for employers to offer insurance. The bad news is

three-fold: First, the subsidy encourages employers to put more of our compensation into tax-free premiums, which leaves us with lower wages. Second, since subsidizing something gets you more of it, subsidizing insurance encourages over-consumption of health care, which drives up prices for everybody. Third, the government loses up to $200 billion a year on this tax subsidy, and most of that money goes to wealthier families who could probably afford to pay more, as this graph from the Center on Budget and Policy Priorities helps to show:

The Debate

The health care subsidy is a nice gig for employers, but almost all economists agree that it amounts to a boondoggle leaving us with lower wages, rising health care prices, billions of wasted dollars, and less money left over to pay for programs like Social Security, defense and education. So how do we fix it?

Start at the top. It makes no sense to give millionaires tax-free health care. We should put a limit or cap on the amount of insurance you can buy tax-free. Indeed, we already have. The health care overhaul begins to tax expensive (or "Cadillac") insurance plans in 2018. Every subsequent year, the tax is scheduled to hit more and more plans, slowly seeding taxes into health care.

Others propose to turn the health care exemption into a credit. That way, rather than shield your entire insurance plan from the IRS, you could reduce your tax burden by a fixed percentage of your premium spending. The upshot is a slightly smaller tax benefit for most people, and a much smaller tax benefit for the rich.

Employers will kvetch that adding a layer of taxes will make health care unaffordable for companies, pushing workers into the poorly regulated individual market. They're right. That's why any plan to tax premiums should also build a way for workers to get insurance on their own. By establishing a system of regulated exchanges that lets families compare plans and prices the way they would compare tech products online, the health care reform provides a safety net for workers in a world where you don't need a boss (or a $200 billion subsidy) to get health care.