Clarifying The Employer Tax Exclusion

In an otherwise very informative paper on the use of tax policyto achieve health policy objectives, Jason Furman (May/June08) asserts that eliminating the employer exclusion "would causea large number of employers, especially smaller employers, todrop coverage." The total elimination of tax subsidies for employercoverage might indeed cause some employers to drop coverage,but a simple tax cap of the type that was proposed by the Reaganadministration (1984) and by the Advisory Panel on Federal TaxReform (2005) is not one of them. Lumping these quite differenttax policy proposals together sends a misleading message aboutthe effects of a tax cap.

If a limit were placed on the cost of employer coverage thatcould be excluded from an employee’s taxable income, firmsthat now offer health insurance would have strong incentivesto offer policies that allowed employees to avoid additionaltaxes. Firms that offered employees a choice of policies couldoffer at least one that stayed below the cap. Firms that offeredonly one plan could redesign it to make sure no worker facedan additional tax burden. Furman is correct to point out thatthis approach could reduce costs and to recommend that we leaveit to market forces to determine the most efficient form ofhealth insurance. As such, we could avoid our past errors inpromoting health maintenance organizations (HMOs) or healthsavings accounts (HSAs) as the exclusive answer to all healthpolicy problems.

The result of these realigned incentives would be to increasethe proportion of workers who are covered by more cost-effectivepolicies with the potential to lower the cost of coverage forall. At least some of the smaller firms that do not now offerinsurance would then have new options to offer less costly coverage.The result would be an increase in employer-group coverage,not a decrease.

The effects of sixty years of tax policy are thoroughly woveninto labor markets and health insurance design. If this open-endedtax policy has caused us to develop an inefficient form of healthcare delivery, then it seems logical that some sort of limitcould start us on the path to a more cost-effective system.Reforms of the individual insurance market would help, but thegreatest potential for improvement is in the employment sector,where three-fifths of our population now receives coverage.

Robert B. Helms
American Enterprise Institute, Washington, D.C.

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Clarifying The Employer Tax Exclusion