NCPA - National Center for Policy Analysis

Tax Exemption for Health Benefits on Its Last Leg?

December 3, 2010

Though it's uncertain whether the next Congress will enact meaningful budget reform, there's reason to believe that once sacrosanct tax benefits could soon be canceled in the name of deficit-trimming.  The Associated Press recently spread the word that a deal to axe the tax-exempt status of employment-based health insurance benefits may be possible.  This would make employers' contributions to their insurance plans count as taxable income for employees, cutting off a much beloved subsidy and potentially bringing the federal government over $100 billion in previously forgone income taxes, says David Godow, a research assistant at the Reason Foundation.

The exemption has come under fire from budget reformers not only for its direct cost to the government, but for the way it may actually increase health care costs for the general population.

  • By not taxing employer-provided health insurance benefitsin the same way as wages, it effectively subsidizes those benefits.
  • As a result, eligible taxpayers face less than the full cost of their insurance, encouraging them to demand more generous benefits than they could afford themselves.
  • Higher demand, of course, fuels higher prices for health care.
  • Thus, while the exemption might make health care more affordable for certain families, it likely also contributes to the more general rise in health care costs.

It's also uncertain whether the benefits of the subsidy are even concentrated among those who can least afford health care.  As a report by the Health Policy Consensus Group notes, the rich enjoy a greater share of the subsidy since they "demand the most expensive health coverage and medical treatments."  Those who don't receive health insurance through their employer because, say, they are low-wage hourly workers, see no benefit whatsoever, says Godow.

There's no doubt that the health benefit tax exemption is popular, but policymakers shouldn't allow that to obscure the toll it takes on our fragile budget, nor the fact that it may actually increase health care costs in the aggregate.

Source: David Godow, "Tax Exemption for Health Benefits on Its Last Leg?" Reason Foundation, November 30, 2010.

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