Cadillac tax or Yugo tax: Which one would be better?

Yugo Tax anyone?

The main provisions of the Affordable Care Act are already in place, but a pretty important one is slated for 2018: a 40 percent excise tax that applies to the portion of employer-sponsored health coverage whose cost exceeds roughly $28,000 per family (or $10,000 per individual). This so-called “Cadillac Tax” is making people nervous, including traditional supporters of the ACA such as labor union leaders, who often negotiate generous benefits.

As usual, repealing this somewhat unpopular provision will be harder than it seems, especially since the tax is expected to raise about $80 billion over ten years and would need to be replaced by something that raised or saved an equivalent sum.

(The term “Cadillac” as a stand-in for high-priced luxury, is kind of quaint. Remember Cadillac dog food?)

There are actually two good reasons for this tax. First, it is one of a variety of funding mechanisms to help subsidize the cost of insurance for people with low and moderate incomes

Second –and controversially– It starts to phase out the tax deductibility of health insurance. Tax deductibility for health insurance is very popular. As a business owner I like it, but as with other tax code special treatment like interest deduction on mortgages, it does distort the market. The distortion causes employees and employers to favor a one dollar increase in health benefits over a one dollar increase in wages. It’s not the only reason health insurance and healthcare costs have risen so much for so long while wages have stagnated, but it’s one reason.

It would be impossibly disruptive to get rid of health insurance deductibility all at once. The Cadillac Tax reduces deductibility gradually by indexing the tax threshold to general inflation, which has been running significantly lower than medical inflation. If those trends continue, the Cadillac Tax will affect more and more employers over time. (It would then be like the unindexed, Alternative Minimum Tax, originally designed to hit the richest but now falling mainly on the middle class –causing confusion and unfairness.) If health insurance inflation is reduced, then fewer companies will be affected.

If we don’t like the Cadillac Tax, there is an alternative, more broad-based approach that could raise as much funding while more directly accomplishing the goal of reducing or eliminating the tax deduction for health insurance. Call it the Yugo Tax or the Yugo/Cadillac Tax if you prefer. Here’s how it would work:

Eliminate the tax break on the first dollars of health insurance costs, maybe the first few hundred dollars or so to start. Increase the amount gradually over time. This would be analogous to the Social Security portion of FICA, which is charged on the first dollars of income but not the last. The amount excluded from tax deductibility would not need to start high because it would affect everyone.
Reduce the impact of the Cadillac tax by increasing the threshold at which it kicks in and lowering the tax rate.
As the Yugo/Cadillac Tax delivers more revenues, reduce other taxes or use the proceeds to reduce the deficit.

The main worry is that employers would stop offering health insurance to their employees over time as deductibility was phased out. Maybe they would, but maybe that’s ok. The Obamacare exchanges are doing pretty well, and if more people used them the markets would function even better. Competition for individual business would do more to keep health insurance costs down than trying to get employers to act.

As a sweetener for the introduction of the Yugo Tax we could drop the employer mandate. Who really needs that anyway?

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By healthcare business consultant David E. Williams, president of Health Business Group.