The Risks And Rewards Of Taxing Health Benefits

Health care costs i i

hide captionAs far as economists are concerned, employee health insurance is still just another kind of paycheck — but a paycheck that isn't taxed.

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Health care costs

As far as economists are concerned, employee health insurance is still just another kind of paycheck—but a paycheck that isn't taxed.

iStockphoto.com

For lawmakers looking for a way to fund a health care overhaul, employee benefits are a juicy target. Taxing those benefits could raise as much as $150 billion a year. But that's not what excites heath care economists: They say taxing benefits also could make the system work better.

"This is one of the rare circumstances where you could actually raise money while improving efficiency," said Katherine Baicker, an economist at Harvard's School of Public Health.

She cites an economic axiom: When you tax an activity, you get less of it. When you subsidize an activity, you get more. "We're subsidizing health insurance," Baicker said. "So we're getting more and more and more health care consumed."

Because workers don't pay taxes on health benefits received through their employers, they're effectively getting benefits at a discount. And as anyone who's ever walked out of the wholesale store Costco with more groceries than he planned on buying knows, a discount can skew a person's decision-making.

"Just like for anything else, if you got 30 percent off on your next car purchase, you'd probably buy a bigger car," said Leonard Burman, director of the Tax Policy Center in Washington, D.C.

America has ended up with the Hummer of health care systems: big, costly and inefficient.

Backdoor Compensation

The roots of the problem date back to World War II, when wages were capped by the government and more employers started offering health insurance as a backdoor way to compensate employees.

As far as economists are concerned, employee health insurance is still just another kind of paycheck. But, Massachusetts Institute of Technology economist Jon Gruber explained, the IRS treats health benefits differently.

"Suppose that MIT is deciding whether to give me a fancy new dental benefit that costs $1,000, versus giving me a $1,000 raise. If they give me that $1,000 raise, I only get to take home $600. If they give me the fancy new dental benefit, I'll get the whole $1,000 worth. So even if I don't want it that much, I might still say that's better than wages, because I won't get taxed," Gruber said.

As a result, many workers who get insurance through their employers end up with more than they need. And much of the additional health care they use is wasted.

"Some estimates suggest 30 percent of health care dollars are going to care that does very little to promote health," Baicker said. "Meanwhile, uninsured people don't have access to care that would very much improve their health."

Unequal Benefits At Tax Time

Economists also complain that the tax break on employees' health insurance disproportionately benefits wealthy workers who need it least, while workers who buy their own insurance — or do without — don't get a tax break at all.

None of these academic arguments is very persuasive to union leaders, who say employees' health benefits have been hard won over the years, often at the cost of pay raises. They're reluctant to see those benefits become a tax target, just because that's where the money is.

"The justification comes from all of the ivory tower economists who say if you were to tax these benefits, it would make everybody more cost-sensitive in health care and help to hold down costs — for which, I submit, there is no factual evidence," said Gerald Shea, who monitors health policy for the AFL-CIO.

Shea worries that just the threat of taxing benefits could torpedo the political chances for a health care overhaul.

"If you wanted to give the opponents of health reform a silver platter to campaign on, try taxing health benefits," he said.

Supporters say any tax could be limited to affect only the most generous insurance policies and perhaps only wealthier workers. Such a limited tax could still raise significant revenue to expand health care and could still make the system more efficient. In the coming weeks, though, as plans are debated on Capitol Hill, what's efficient is likely to take a back seat to what's politically doable.

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