Tax reform and health policy should be linked — just not via the individual mandate

  • Tax reform and health policy are inexorably linked, despite protests that they are separate.
  • Republicans have a unique opportunity to significantly improve health insurance markets and produce the conditions for truly revenue-neutral and conservative tax reform.
  • This would involve repealing the tax break for employer-provided health insurance.
Hundreds of New Yorkers gathered outside Cipriani at 42nd Street in Midtown Manhattan on December 2, 2017.
Erik McGregor | Pacific Press | LightRocket | Getty Images
Hundreds of New Yorkers gathered outside Cipriani at 42nd Street in Midtown Manhattan on December 2, 2017.

As Republicans come to grips with the ramifications of their tax legislation, it is becoming clear that any hope of a revenue-neutral and conservative tax reform is fading.

Complicating matters further, Republicans have combined health policy and tax reform in the form of repealing the Affordable Care Act's individual mandates. Many have protested this move – partly under the rationale that health policy and tax reform are two different efforts.

But this isn't really true. Given the complexity of our tax code, health and tax policy are inexorably linked. The problem isn't jointly thinking about health and tax policy, it's that the Senate Republicans are simply looking at the wrong health policy options. As a result, their tax plan increases the share of uninsured and blows a hole in the budget.

It doesn't have to be this way. In the coming conference committee, Republicans have a unique opportunity to significantly improve health insurance markets and produce the conditions for truly revenue-neutral and conservative tax reform: repealing the tax break for employer-provided health insurance.

In the U.S., most privately insured individuals receive coverage as part of their compensation. While there are many reasons for this, a primary motivation is that, unlike wages, these benefits are not subject to income or payroll taxes. This amounts to the nation's single largest tax break, costing over $230 billion in forgone taxes each year.

A tax break of this size requires the U.S. to charge everyone higher tax rates on income than would otherwise be necessary. Ending this tax break and lowering rates across the board could increase competition in health-care markets and contribute to economic growth, a truly conservative tax plan.

In addition to the direct cost, as long as the tax exclusion exists it continues to prop up the inefficient employer-provided insurance market — a system that effectively traps some employees, such as mature people who don't yet qualify for Medicare, in the labor market. As a result, these employees are restricted from moving to the best jobs for their skills and talents because they are concerned about losing their health insurance if they leave.

Employer-provided insurance also puts new and small firms at a disadvantage because they have difficulty providing benefits at the same rate as large incumbents. These higher costs make it harder for entrepreneurs to start new companies and hire talent, thereby undermining innovation and harming economic growth.

Given the economic costs of employer-provided insurance, Republicans should address a major source of economic inefficiency and improve the American health-care market – two goals that eluded them during the repeal-and-replace debate. In addition, the revenue gains from ending this tax break generate the necessary funds to offset an across-the-board reduction in the marginal income tax rates — reducing the inefficiency created by high rates.

Some may argue that such a tax cut would disproportionately benefit the rich. While this is true, it is the result of the regressive nature of the existing tax break where taxpayers earning less than $30,000 enjoy $1,650 in benefits compared with $4,580 in benefits for those earning over $200,000. Overall, the bottom half of the income distribution enjoys only one-sixth of the benefits from this tax break, while the upper half enjoys the remaining five-sixths. Since higher-income taxpayers will bear a disproportionate cost if we begin to tax employer insurance, it only makes sense that they would ultimately benefit more from a corresponding tax cut.

While many Democrats will reflexively oppose any tax break that disproportionately benefits the wealthy, ending the employer insurance tax exclusion could also benefit the Obamacare marketplaces by creating new healthy customers for these insurance plans. Certainly, one reason Obamacare has struggled is that many of the healthy, higher-income individuals needed to stabilize these markets are handcuffed to their employer insurance. Now, America could create the conditions allowing a robust nonemployer health insurance market to emerge and flourish.

Surely some Democrats would trade off their inherent desire to tax the rich for a policy that supports their party's prized health insurance accomplishment.

There will also be strong opposition from private firms that currently benefit from the attractiveness of employer insurance. However, this can't be a fundamental barrier to efficient tax reform. Any policy that lowers the rate and broadens the base will face pushback from those most directly affected. If Congress is serious about reform, lawmakers must fight against opposition and support conservative policies that improve economic efficiency despite their costs.

Public opinion sees Congress as being unable to create policies that can gain the support of both parties. Now, the combination of tax reform and ending the employer exclusion for health insurance are the ingredients for the type of legislative compromise that has eluded Congress for far too long.

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