Earlier this week, I spoke to NPR about “Cadillac health plans,” which are drawing attention in current health care reform negotiations. Just what is a Cadillac health plan? The health care reform bill passed by the Senate over the holidays would impose an excise tax on insurers of employer-sponsored health plans with aggregate values that exceed $8,500 for individual coverage and $23,000 for family coverage. Further details of this provision and a comparison of the Senate and House Bills are provided on the Kaiser Family Foundation‘s Web site.
In general, health economists view the taxation of employer-provided health insurance as a good idea. Currently, employees’ wages are subject to income tax, while employer-provided health insurance is provided to workers tax-free. This imbalance leads workers to purchase relatively more generous health insurance than they would if this benefit were taxed. That is, if a worker facing a marginal income tax rate of 25% has a choice of receiving a $1,000 annual raise in cash, he will earn $750 after federal income taxes. He may instead choose to purchase a more generous health insurance policy that costs $1,000 more and pay no additional taxes.
Taxing Cadillac plans is also likely to control the growth in health care costs over the long run. The proposed tax rate is equal to 40% of the value of the plan that exceeds the threshold amounts of $8,500 and $23,000. This high tax rate will be a strong incentive for employees to elect less expensive health insurance plans, which tend to have higher deductibles and copayments. With greater cost sharing on the part of consumers, they will consume less health care, which will lower overall spending. Assuming that health insurance markets are relatively competitive, these cost savings will be passed on to companies in the form of lower health insurance premiums for the following year. Thus, taxing expensive health insurance premiums could save all of us money in the long run.
As a reality check, I pulled out my Rice benefits book and looked at the cost of our health plans. Like most major employers, Rice offers more than one health insurance plan to its employees (four, in fact), with wide variations in price and corresponding benefits. I have a, POS plan, which allows me to see a specialist without obtaining a referral from my primary care doctor. I pay a $25 copay to see my primary doctor and $35 to see a specialist. The combined “value” paid by me and Rice for my health plan is $6,048 for this year. If I had instead chosen Rice’s PPO plan, I would pay lower copays of $20 for a primary care office visit and $30 for specialist care. The value of my plan would be $9,684. So, under the proposed new tax, I would be taxed on $1,184 — the difference between $9,684 and $8,500. My actual tax bill would be 40 percent of that, or $473.60.
There are several other differences between these two plans offered by my employer. However, none of these differences is Earth-shattering. The POS plan offered by Rice, which would not be subject to a Cadillac tax, is still an excellent health plan. Thus, if we could eliminate the PPO option for my employer, we might very well see slower growth in health premiums at Rice.
These comments come with the caveat that health insurance markets must be relatively competitive in order for savings to be passed on to consumers. The health care reform bills have some measures aimed at increasing competition, but not enough, in my view. However, the plan to tax high-cost health insurance plans makes economic sense, and it will raise revenue which is needed to cover the costs of expanded access to health insurance for low-income families in the U.S.
Vivian Ho is the James A. Baker III Institute Chair in Health Economics, and she is an associate professor in the department of medicine at Baylor College of Medicine. She is also a professor in the department of economics at Rice University. Ho’s research examines the effects of economic incentives and regulations on the quality and costs of healthcare.