How Republicans in Congress will fulfill their promise to “repeal and replace” the 2010 Affordable Care Act remains uncertain. Nevertheless, there is at least one issue on which lawmakers increasingly agree: limiting the tax exclusion for employer-provided health insurance, under which an employee may exclude from tax the value of employer-provided coverage under a qualified accident or health plan. But the imposition of a cap on the exclusion could have a significant effect on businesses.
Cap versus ‘Cadillac’
In their 2016 tax plan, “A Better Way,” House Republicans proposed a cap on the exclusion and described it as a “fundamental departure” from the current-law ACA “Cadillac tax” provision, which imposes a 40% excise tax on insurers providing high-cost employer-sponsored health coverage that exceeds specified thresholds.
Originally scheduled to go into effect in 2018, the Cadillac Tax was delayed by the Consolidated Appropriations Act of 2016 until 2020 (now scheduled to apply to tax years beginning after December 31, 2019.) In 2020, the thresholds are projected to be $10,800 for individual coverage and $29,250 for family coverage. The repeal of the ACA that passed Congress in 2015 would have eliminated the Cadillac tax, but that legislation was vetoed by President Obama.
Various cap proposals have been offered. One 2015 proposal – in a bill introduced by then Rep. Tom Price (R-GA), who is now the Secretary of Health and Human Services – would have capped the employer sponsored exclusion in 2016 at $8,000 for individual coverage and $20,000 for family coverage. Any overage would be treated as taxable compensation for income and employment tax purposes. Other GOP proposals would repeal the exclusion and instead offer a tax deduction to all individuals with either employer or non-group insurance coverage.
Cap Proposals Seek ‘More Parity’
The 2016 GOP white paper notes that economists generally recognize the distorting effect of the current tax treatment of employer sponsored insurance. This unlimited exclusion is viewed as contributing to higher health care costs, increasing employer premiums, contributing to a lack of growth in take-home pay, and as regressive in effect, because it is more beneficial to higher-income individuals.
The GOP plan to impose a cap seeks “more parity” in the treatment of health care costs between employees with employer sponsored coverage and other workers, including independent contractors.
The white paper says that most health plans likely would change their design to avoid exceeding the cap by shifting compensation away from health care and toward taxable wages. Some employer and labor groups are expressing opposition to a cap, arguing it could add to employer costs, lead to increased taxes on employees, and destabilize the employer-provided health insurance system.
The framers of the proposal hope that limiting the exclusion for employer sponsored coverage would alter employer and employee behavior. Similar to the Cadillac Tax, the purpose would be to shift compensation away from employer sponsored coverage and into wages or other taxable forms of compensation.
The challenge, as was the case with the Cadillac Tax, is that Congress does not legislate against a blank slate. There are economic arrangements that have evolved over time in response to (and arguably encouraged by) the current tax treatment of employer sponsored insurance.
Thus, while the economics of the proposed cap may make perfect sense, the politics of it are far from clear. Adding to the complexity is the estimated cost of the present-law exclusion: $266 billion in foregone income and payroll taxes (in 2016), according to staff of the Joint Committee on Taxation.
Other Possible Tax-related Changes
Besides the Cadillac Tax, tax provisions that could be eliminated when Congress considers ACA repeal include
- the 3.8% tax on net investment income and 0.9% Medicare premium surcharge that apply to upper-income individuals;
- penalties for violating the employer and individual mandates for health coverage;
- premium tax credits and subsidies for insurance purchased on the ACA exchanges;
- the tax on health insurance providers;
- the excise tax on medical devices; and
- the annual fee on branded pharmaceutical manufacturers.
Some of these provisions were temporarily delayed or suspended by legislation enacted in 2015. The net investment tax and Medicare surtax appear likely to be fully repealed as part of current ACA legislative efforts. But Congress might choose to merely delay certain other provisions in order to fund an ACA replacement plan.
Other changes that may affect employers in either a “replace” or “repair” scenario include a push for greater use of health savings accounts and flexible savings accounts. Currently, these accounts offer employees the opportunity to make pre-tax contributions up to certain amounts. Changes may include, for example, an increase in those contribution limits.
The Meaning for Businesses
Actions in 2017 relating to ACA repeal and replacement could have a significant effect on businesses. Specifically with respect to the tax exclusion for employer sponsored insurance, finance executives should be prepared for some type of cap to be in place after 2017. And they should continue to consider how changes could affect current employee compensation and benefit strategies. If a cap is imposed, will employers rethink their choice of benefit offerings, and, if so, what would be the cost impact?
Rather than providing more generous health coverage, will companies need to provide additional, more varied benefits in order to attract and retain workers? If employers are experiencing rising health care costs related to their employees, will they increasingly seek creative ways to mitigate costs, such as raising deductibles or asking employees to bear a greater share of the costs in other ways? Companies will need to find balance between these competing trends.
Changes to how employer sponsored coverage is taxed also could mean evaluating existing systems and procedures that govern benefit reporting to employees and the IRS. The ACA already requires employers to report the cost of coverage under an employer sponsored group health plan on employees’ Form W-2. But what additional system and process changes may be required if a cap or limit is imposed?
Only time will tell. But it seems likely that changes are coming, and paying attention to policy developments in Washington continues to be a wise investment of time.
Rohit Kumar is PwC’s tax policy services leader and a former deputy chief of staff to Sen. Mitch McConnell, the current majority leader.