The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Will We Ever Pay the ‘Cadillac’ Tax?


Howard Gleckman of the Tax Policy Center has written an excellent post on the taxes included in the new health legislation. Gleckman is a straight-shooter, who recently wrote a smart assessment of Rep. Paul Ryan’s Roadmap, suggesting that it was offering overoptimistic revenue assumptions. He is not, as far as I can tell, a partisan right-winger who is bitterly opposed to universal coverage because it is an entering wedge of some kind of socialist apocalypse. He is, however, very knowledgeable about the extent of the revenue needs of the federal government, and he has followed tax policy debates for many years. And so I found his take on the various revenue provisions of the new health legislation very useful.

I have never quite seen a law so full of powerful tax bombs attached to delayed fuses. The two biggest: A stiff new Medicare tax on high-earners that does not bite until 2013 and a tax on high-cost health insurance that does not kick in until 2018—long after the end of an Obama second term, if he has one.

I urge you to read the post in its entirety. I will offer some quick thoughts. I’ve added emphasis throughout.

Take the Medicare tax. Singles earning more than $200,000 and couples making more than $250,000 (in modified adjusted gross income) would pay an extra 0.9 percent of their wage income. Plus, they’d pay an entirely new tax of 3.8 percent on investment income. This effectively raises the rate on capital gains and dividends from 15 percent to nearly 19 percent. Initially, only about 2 percent of taxpayers would face the higher rates. But in an echo of the disastrous Alternative Minimum Tax, the earnings floor is not indexed for inflation so eventually many middle-class taxpayers could be hit by the levy. By 2018, the new tax would generate $37 billion.

Note that the AMT tax is regularly “patched,” which is why many suggest that assuming that the AMT will be left unfixed is a politically unrealistic assumption. One could just as easily argue that revenue projections premised on an unindexed earnings floor for the new Medicare tax are similarly unrealistic. 

The “Cadillac” tax on high-cost health insurance is the fave of nearly every economist, although it is widely disliked by the public. The current system that excludes the value of health care from tax is unfair since it is far more beneficial to high-earners (whose after-tax cost of insurance is reduced by 35 percent) than to low-wage workers (whose cost may be reduced by only 10 percent). It is also a big reason why consumers of health care are so disconnected from the true cost. After all, who cares about getting that unnecessary MRI if insurance is paying anyway? 

Taxing those high cost health plans would encourage employers to offer cheaper policies, and workers could expect to get at least some of the cost savings back in wages, though economists argue endlessly about how much.

Like a number of conservatives, I’m in favor of the “Cadillac” tax, and my main concern is that it has been weakened excessively. It’s not as good or as clean an option as ending or capping the tax exclusion for employer-provided health insurance, but it’s better than nothing. Peter Orszag and Nancy-Ann DeParle have argued that the proposal is still a strong one. Gleckman expresses some skepticism.

There are all sorts of exceptions. And the tax is indexed for inflation plus 1 percent. Today, the average family policy costs less than $14,000, far below the threshold. But since health costs have been growing much faster than regular inflation+1, the new tax would eventually hit many more workers—unless we can control medical costs. This tax is potentially a health care game changer. But it won’t take effect for 8 years.

Note that this recapitulates the AMT problem. And the 8-year-delay is very significant. 

Will any of us ever pay either tax? Who knows? The odds are very high that Congress will enact a significant tax reform long before anyone ever pays the Cadillac tax. And unions are poised to kill it. Similarly, the Medicare tax will be hugely controversial. Plus it eliminates a major revenue option for those who want to find new taxes to help balance the budget.

Gleckman could be wrong about all of this. But he knows what he’s talking about.


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