Capping the Tax Exclusion for Employment-Based Health Coverage: Implications for Employers and Workers

January 2009
EBRI Issue Brief #325
Employee Benefit Research Institute, 2009

Executive Summary

HEALTH CARE TAX CAP - With health reform a major priority of the new 111th Congress and President Barack Obama, this Issue Brief examines the administrative and implementation issues that arise from one of the major reform proposals: Capping the exclusion of employment-based health coverage from workers’ taxable income.

CURRENT TAX TREATMENT - The amount that employers contribute toward workers’ health coverage is generally excluded, without limit, from workers’ taxable income. In addition, workers whose employers sponsor flexible spending accounts are able to pay out-of-pocket expenses with pretax dollars. Employers can also make available a premium conversion arrangement, which allows workers to pay their share of the premium for employment-based coverage with pretax dollars.

TAX CAP RECOMMENDATIONS - In 2005, a presidential advisory board concluded that limiting the amount of tax-preferred health coverage could lower overall private-sector health spending. The panel recommended a cap on the amount of employment-based health coverage individuals can exclude from their income tax, as a way to reduce health spending. In his 2008 “Call to Action” for health care reform, Sen. Max Baucus (D-MT), chairman of the Senate Finance Committee, states that “Congress should explore ways to restructure the current tax incentives to encourage more efficient spending on health and to target our tax dollars more effectively and fairly.”

IMPLEMENTING A TAX CAP - While a tax cap on health coverage sounds simple, for many employers, it could be difficult to administer and results would vary by employer based on the type of health benefit plan, the size and demographics of their workforce, and even where the workers live. The change would be especially difficult for self-insured employers that do not pay insurance premiums, since they would have to set the “premium equivalent” for each worker. This would not only be costly for employers, depending upon the requirements set out by law, but could also create fairness and tax issues for many affected workers.

ADMINISTRATIVE COSTS - For self-insured employers, calculating insurance premium costs under a tax cap could be done fairly easily using the COBRA premium. However, whether self-insured employers would be able to use the least costly method to determine the value of coverage would have to be determined by law and/or regulations.

THE SEC. 89 EXPERIENCE - Sec. 89 of the Tax Reform Act of 1986, which attempted to make employee benefits more standard and fair, became so controversial that it was repealed by Congress in 1989 - in part because the regulations created regulatory burdens that were so complicated and costly as to be unworkable. Similarly, valuation calculations under a health coverage tax cap could become overly burdensome if the lessons from Sec. 89 are not heeded.