End the Employer Tax Exemption for Health Coverage

One of the most important health care reforms we could enact would eliminate an inefficient, outdated tax exemption that is still a fundamental part of U.S. policy.

This is how it works: If a company provides health insurance to its employees, the federal government does not tax the health benefits that are being provided. Say you have an insurance policy worth $5,000. The company deducts a part of the employee’s salary—say, $1,000—for “health insurance.” But the majority of the cost, the other $4,000, is hidden because the company negotiates directly with health care providers. This is an enormous tax exemption, amounting to the biggest the federal government gives.

On the surface, it sounds like a good idea. Who wouldn’t want to encourage companies to provide health insurance?

The problem lies in the unintended consequences of this tax exemption. An employee receiving health insurance from his employer has an incentive to get the most expensive, technologically advanced treatment possible—even if such treatments are not proven to be effective. After all, the company’s paying for most of the cost. Who wouldn’t want to get the costliest treatment possible if you’re not paying for it?

Except the employee is paying for that other $4,000—just not directly. He’s paying in the form of lost wages that the company would have given him instead of the health insurance it provides. For example, instead of paying the employee $50,000 in wages, Company A decides to offer everybody a $5,000 health insurance packet and pay him $45,000 (and put a $1,000 health insurance deduction on his paycheck), due to the government tax exemption.

But the employee doesn’t know how much more he could have made without the tax exemption. All he knows is that he’s getting cheap health insurance and that he’d better use it on the most expensive, cutting-edge treatment possible.

In effect, the employee is spending $5,000 of his own paycheck in an inefficient, wasteful manner. But he doesn’t know this and doesn’t consider it his money because of the way our health care system works. If said employee were given $5,000 in wages instead of a $5,000 health insurance plan, he’d probably be less likely to seek that $100,000 prostate cancer detection test (which studies show doesn’t work). And we’d all be better off for it.

There are two other complications that arise from employer health benefit tax exemptions, as if the above weren’t enough. The first problem is what happens when you lose your job. That’s when health insurance is most necessary—and when it’s often missing. Moreover, employees are discouraged from switching jobs because of the possibility of downgrading quality of health insurance. This reduces productivity and market efficiency on a macroeconomic scale.

The second problem is that due to the tax exemption, the government helps the rich and hurts the poor. The rich are far more likely to have employer-provided health insurance than the poor. Goldman Sachs probably gives its bankers gold-plated insurance, whereas a contract construction worker probably doesn’t have any company insurance at all. In effect, the government is giving a tax break to the rich because they’re the ones who most often benefit from these insurance plans.

Ending this tax break is not only sensible but necessary. It would greatly reduce costs and raise hundreds of billions of dollars at the same time. It would help consumers. It would end a regressive system that helps the rich and hurts the poor.

Unfortunately, unions—a core constituency of the Democratic coalition—are vehemently opposed to the reform. For unions, this tax exemption remains one of their most holy accomplishments throughout the years. Taking it away would be an anathema to them.

In a compromise, the Senate health care bill has agreed to end the tax break for only certain, high-end health care plans. Under President Obama’s new proposal, however, unions would be exempt from this change until 2018. Obviously, this is not an ideal situation; it represents a compromise of something that was already a compromise. New York Times columnist David Brooks thinks the reform will never happen and that the Congress of 2018 “will probably get around the pay-go rules or whatever else might apply and it’ll postpone the tax again.”

This is sad, because by caving into short-term political considerations, Democrats stand to hurt their long-term political futures. Unions might not be happy with the bill, but a good, effective bill is always going to leave somebody unhappy. The 1964 Civil Rights Bill left some Southerners pretty unhappy, but today it is regarded as LBJ’s greatest accomplishment. If Obama ends tax breaks for employer-provided health care, he’ll have done a great deal to fix our current health care system. In 20 years, nobody will remember that unions were pissed off by Obama’s health care bill. They’ll remember that it worked.

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