Republicans are considering a controversial tax to pay for Obamacare reform — and it’s a good idea

Health insurance provided by your employer is free from income and payroll tax, regardless of how expensive the insurance is.

But House Republicans are considering changing that as part of a plan to pay for changes to the Affordable Care Act, according to a recent report from Bloomberg. Your health insurance would be excluded from tax only up to a cap. Above that, you would be taxed.

This would be a good idea.

The tax exclusion for health insurance distorts healthcare markets, encouraging people to spend more on healthcare than they otherwise would. It also helps drive up healthcare costs by making consumers less sensitive to prices. Imposing a cap would both raise revenue and help to control overall healthcare costs.

Unfortunately, as Republicans may be about to learn, this good idea would be very unpopular. They’re preparing to stick their fingers in an electrical socket.

People hate having to pay new taxes

In 2008, then Republican candidate John McCain ran for president on a similar idea: The tax exclusion for health insurance should be replaced with a flat tax credit – enough to offset the tax paid on an ordinary plan, but not providing additional benefits for people with very expensive plans.

Barack Obama, unsurprisingly, ran television ads attacking McCain for wanting to “tax your healthcare benefits for the first time ever.”

After winning the election, Obama needed to find new revenues to pay for an expansion of healthcare coverage. Instead of capping the insurance tax exclusion, Democrats found a clever workaround: They would impose a “Cadillac tax” of 35% on health-insurance premiums paid by employers over a high cap.

Because the Cadillac tax would be charged to the employer, not the employee, it is not technically a tax on employees’ health benefits. But economically, the effects are the same: Employers are discouraged from offering very expensive plans. And the higher cost of offering health benefits tends to reduce the amount employers pay in salaries, at least in the long run.

The Cadillac tax became law as part of the ACA, but partly because of the political sensitivities – many of the beneficiaries of the expensive plans that would be subject to the tax are union members – it wasn’t supposed to be effective until 2018. In 2015, the tax was delayed for another two years, until 2020, as part of a budget deal.

It isn’t obvious the tax will ever become effective.

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House Speaker Paul Ryan.
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Chip Somodevilla/Getty Images

Most healthcare policy is about how to divide the pie

While there is a lot of talk about innovation, competition, and consumer choice, the politics of healthcare are mostly about who will receive services and who will pay for them.

The ACA didn’t revolutionize the American healthcare system. It just created new rules about who pays and who benefits.

The ACA created new benefits to pay for health insurance for people with low and lower-moderate incomes. It paid for these changes by cutting Medicare (benefits for older people) and by raising taxes – mostly on high earners, but also on certain healthcare products and services, thereby spreading costs to everyone who receives healthcare.

If Republicans change the law again, the changes would mostly be about how to redivide the pie. They’d want to benefit Republican constituencies, especially high earners who pay Obamacare taxes.

The problem they are finding is that if you take the pie slices away from low and lower-moderate earners who got coverage because of the ACA, they will notice. Healthcare providers, who depend on payments for care made possible by the ACA, will also notice.

Continuing to provide those beneficiaries with enough coverage so they don’t get angry would be expensive – hence the need to find new sources of revenue, especially if Republicans wish to repeal the high-earner taxes in the ACA that bother them so much.

Given that need, the tax exclusion for employer-sponsored insurance is a tempting place to look for money. Excluding health benefits from income and payroll taxes costs the federal government approximately $250 billion a year.

Affluent professionals and union members are adept at protecting their tax benefits

The problem: The group of people who benefit most from the tax exclusion for employer-provided health insurance is politically powerful – perhaps even more powerful than the very rich.

The politics of capping the tax exclusion for health insurance would be similar to the politics of Obama’s doomed proposal to abolish the tax benefits for deposits into 529 college-savings accounts. As Obama correctly pointed out, 529 plans mainly benefit affluent families whose children are very likely to attend college whether or not their parents receive a tax break.

When I wrote in defense of scrapping the 529 tax break, I got a lot of angry mail from affluent people indignantly protesting their non-affluence, including one woman who wrote about how her family was “barely scraping by” on $250,000 a year in Los Angeles.

This is exactly what lawmakers would hear if they tried to cap the tax exclusion for employer-sponsored health insurance. After all, when members of Congress aren’t hanging out with ultra-wealthy donors, they tend to spend time with the sort of pretty-wealthy professionals who have high-quality healthcare plans that would be newly subjected to tax at a pretty high rate.

They’d also hear from their well-organized union-member constituents, many of whom prize the high-cost healthcare plans their unions negotiated for them.

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Demonstrators at a “Defund Obamacare Tour” rally in Indianapolis in 2013.
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Thomson Reuters

There is a reason nearly all healthcare policy is unpopular

Healthcare is very expensive – too expensive for most households to bear the risk of major medical events on their own. As healthcare costs have climbed, employers and the government have held down premiums by shifting a greater share of routine costs to the insured.

This ensures that people remain protected against catastrophic costs, but it means they pay more out of pocket every year, and they don’t like it.

If the Cadillac tax eventually becomes effective, or if Republicans succeed in capping the health-insurance tax exclusion, employers will respond by shifting more routine costs to employees to stay under the cap.

People would hate that. They’d also hate paying taxes on their benefits – directly or indirectly – if their employers didn’t strategize to get under the cap.

But everything else you might do would be hated by somebody, too.

If you throw people off their health-insurance plans, they’ll hate that. If you reduce the package of benefits that healthcare plans have to include – so that, for example, women’s plans don’t necessarily cover maternity care – people who are left without the care they need will hate that.

And if you don’t do anything to offset the rising cost of healthcare, the government will have to borrow more and more money, and sooner or later it would have to pay for that with some sort of tax increase or spending cut that people would hate.

Changing healthcare policy is thankless, which is why the tax exclusion for employer health insurance is largely unchanged since World War II, and which is why I suspect the extent of policy changes as part of the ACA “repair” will continue to shrink.