When Congress passed the ACA, the law’s so-called Cadillac tax was touted as targeting lavish health plans, supposedly rare but costly. However, the economic reality today is that the excise tax will hurt everyday workers and the health benefits they have come to rely on.
Employers are actively trying to develop ways to avoid the non-deductible 40 percent tax on employer-sponsored plans valued over $10,200 for individual coverage and $27,500 for family coverage, set to take effect in 2018. But in the process, those employers have begun to impose higher health costs on workers. The time for policymakers and regulators to act is now. The longer they wait the more uncertainty there will be in the marketplace and worker benefits will be harmed.
Legislative Background
When the excise tax was passed by Congress in 2010, the policy rationale was two-fold:
First, the tax was designed to slow the rising cost of health care and put pressure on employers to restructure employee health plans by increasing cost sharing on the part of employees. This would encourage employees to consume less health care, resulting in lower medical spending in the long-term. In order to avoid paying the 40 percent tax, employers have begun to redesign the health benefits offered to employees.
Second, the tax was intended to raise significant revenue to pay for other key components of the ACA, including subsidies to help low- and middle-income families afford coverage through the health insurance marketplaces. Before the President signed the ACA in March 2010, the Joint Committee on Taxation (JCT) and Congressional Budget Office (CBO) scored the tax’s revenue impact and estimated that it would raise $30 billion in additional federal revenue in its first two years (2018 and 2019).
However, there is a conflicting relationship between these two policy goals: The more revenue the tax generates, the greater the pressure to slow-down the cost of health care — presumably a good thing from a long-term budget perspective. Yet, that rising pressure would also have a potentially negative impact on the employee health benefits of many working class Americans.
When the excise tax was debated in Congress in 2009 and 2010, proponents of the tax argued that they were targeting lavish health plans enjoyed by the very few. Unfortunately, five years after the ACA has become law, the surveys and data described below suggest that a growing number of middle class Americans are being negatively impacted — the very group that Congress sought to protect.
If you track the development of the excise tax from its inception in the fall of 2009 in the Senate Finance Committee “mark-up” process (where Congressional committees initially debate and develop legislation before it goes to the full Senate and House), it is clear that lawmakers wanted to craft the tax in a way that minimized its impact on middle class workers.
The first iteration of the excise tax released in the Finance Committee in September 2009 was scheduled to take effect in 2013 at a 35 percent tax rate for employee health plans valued above $8,000 for individual coverage and $21,000 for family coverage. The initial provision was projected to raise $214.9 billion of revenue in the first 10-year budget window. That proposal, however, was met with significant criticism from inside Congress and from outside stakeholder groups, who argued that the tax would hurt middle class Americans whose health plans, they felt, were not extravagant.
Over the next several months, the tax was scaled back significantly in an attempt to soften its impact and protect middle class families and other groups who require more expensive health plans. In response to these concerns, three major structural changes were made to the tax as the House and Senate legislative process moved forward and the ACA was finalized:
- The effective date of the tax was delayed five years to 2018;
- The general threshold limits of the tax were increased to $10,200 for individual coverage and $27,500 for family coverage; and
- Higher threshold limits were created for individuals in certain high-risk professions and pre-age 65 retirees ($11,850 for individual coverage and $30,950 for family coverage).
These changes to the excise tax were significant, indicating that the White House and Congress intended to narrow the tax’s impact on the health benefits of middle class Americans. Nevertheless, it is clear today that policymakers significantly underestimated the effect the tax would have in the health care marketplace, resulting in additional costs for working class Americans.
Unintended Consequences
The tax will likely trigger two general scenarios for employers and employees. First, some employers will reduce employee health benefits to avoid the hefty 40 percent excise tax, while at the same time increase wages in order to make up the difference. Much of the revenue raised by the tax, as estimated by CBO and JCT, is attributed to increased (taxable) wages from this scenario.
The second scenario is a reduction of employee benefits without a pay increase. Both scenarios are not favorable for employees because an increase in pay is not guaranteed, and even if employees see higher wages, that increase may not fully match a reduction in health benefits.
As employers explore ways to lower the cost of their health plans, many are considering shifting costs to their employees in the form of higher deductibles, co-payments, and out-of-pocket maximums. Higher co-payments and deductibles will be particularly onerous for employees in the lower income scale, hit with the harsh reality of having to pay more from their own pockets for medical services. It will also have a significant impact on collectively bargained plans in which employees generally enjoy lower premiums and less cost sharing.
According to an August 2014 study by the National Business Group on Health, 42 percent of employers surveyed will increase employee cost sharing and 37 percent will reduce spousal subsidies or implement a spousal surcharge.
Underscoring this troubling trend, Aon Hewitt conducted a survey in October 2014 which found that 33 percent of employers are reducing the value of their plan designs through higher out-of-pocket costs for their employees. This same survey of 317 employers also found that 14 percent of employers are significantly reducing spousal eligibility or subsidies in order to avoid the excise tax.
So how much more will employees have to pay out of pocket as a result of reduced benefits? According to a November 2014 report by the American Health Policy Institute (AHPI), employees could see up to a $6,150 reduction in health benefits and little or no increase in wages. That rise in health care costs for employees would be regressive, with the impact weighing heaviest on middle class families.
Scope of Employers and Employees Impacted
According to the AHPI study, 17 percent of all U.S. businesses will be hit by the excise tax in 2018, as well as 38 percent of large employers surveyed. In September 2014, Towers Watson, in an analysis of employers with 5,000 or more employees, found that 48 percent of employers are likely to trigger the tax in 2018, with that figure rising to 82 percent by 2023.
That rapid increase in the expansion of those caught in the excise tax’s web is due to the fact that, under the ACA, the dollar level triggering the tax increases only in relation to the Consumer Price Index (CPI), which grows at a significantly slower rate compared to medical costs and inflation.
Those large employers surveyed in the AHPI study that trigger the tax in 2018 will pay an average of $1 million that year, and an average of $2.1 million annually from 2018 to 2024, which is over $2,700 per employee. However, those ranges can vary significantly.
A large employer estimated that the tax could cost them $378 million from 2018 to 2023 — almost $4,500 per covered life, unless they made plan design changes. Another employer estimated their cost at $284 million from 2018 to 2024.
Their exposure to the tax will decrease after employers make changes to their health benefits and shift costs to their employees, although that will not guarantee that they will be protected from the tax. A large employer cited in the AHPI study estimated that the tax would still cost them $78 million in 2018 even after implementing changes trying to shield them from the tax.
This problem is not only limited to private companies, but also encompasses school districts, government entities (federal, state, and local), and colleges and universities. Boston University recently estimated that its current health plan for faculty, staff, and students would be subject to $2.8 million taxes in 2018, and a total of $31.6 million in the following six years.
Enter Policymakers And Regulators
So what can be done by Congress, the Treasury Department, and the Internal Revenue Service (IRS)?
Congress could get rid of the tax, but that seems unlikely for two reasons: First, eliminating the tax would create a sizeable hole in the budget, which Congress would find difficult to fill. Second, Congress has struggled to compromise on legislation over the past few years, particularly on controversial areas such as the ACA. As the Presidential campaign season begins, any legislative solution will be even harder to enact.
Short of eliminating the excise tax all together, Congress could attempt to pass legislation that would increase the dollar thresholds triggering the tax, as well as push back the 2018 effective date. That would not be easy since such changes would surely have a budget impact, forcing Congress to raise revenue somewhere else if it does not want to add to the deficit. Absent action from Congress acting, the focus shifts to the Treasury Department and IRS — the two agencies charged with drafting the implementing regulations for the excise tax.
Treasury and IRS have yet to draw any hard lines on the excise tax. On February 23, 2015 they issued Notice 2015-16, initial guidance asking for public comments around certain key topics. The deadline for submitting comments is this Friday, May 15.
They will use that feedback as they issue future guidance, but it remains an open question if Treasury and IRS will exercise its regulatory authority to provide relief for employers and employees around the issues outlined above.
Section 4980I(g) of the ACA provides Treasury and IRS the authority to “prescribe such regulations as may be necessary to carry out this section” of the legislation. Such grant of regulatory authority is common in tax laws passed by Congress, and while that sentence is concise, it carries significant weight because it allows Treasury and IRS the ability to draft implementing regulations in a manner that carries out the spirit of the legislation as lawmakers intended. That is of particular importance here because of the excise tax’s major economic impact and the risk it poses on the health care benefits of everyday Americans, as outlined above.
The three main factors currently driving employers to redesign their health plans and increase employee costs are: 1) the plan value threshold limits triggering the excise tax ($10,200 for individual coverage and $27,500 for family coverage); 2) the assessment of the tax starting in 2018, and 3) after 2018 the threshold limits will only be indexed to CPI.
If the Treasury and IRS were to draft regulations providing relief around any of those three points, it would certainly relieve pressure on employers actively looking for ways to restructure health benefits. The challenge, however, will be that those three factors are set in the ACA statute, decreasing the regulatory flexibility afforded to Treasury and IRS.
One potential regulatory avenue for Treasury and IRS to explore is delaying the 2018 effective date by implementing a “safe harbor” or “transition period” for the first few years. The policy goal would be to delay the assessment of the tax and give employers additional time to redesign their health plans and lessen the effect on employee benefits. Such regulatory action would have the benefit of calming the waters in the health care marketplace, which would surely benefit from additional compliance time.
If Treasury and IRS decide to take this approach, they can find cover in the statutory history of the ACA. As discussed above, regulators will find that Congress made changes to the excise tax attempting to protect everyday workers and their health benefits from harm. Congress raised the threshold limit, delayed the effective date of the tax, and created higher threshold limits for high-risk professions and retirees. However, those legislative changes did not go far enough and Congress underestimated the broad impact of the tax.
Thus the difficult job now falls on Treasury and IRS to ensure that the excise tax is implemented in a way that minimizes the economic risk for employees and their health plans. It is not an easy task, especially in this politically charged environment, but it is an important one. Treasury and IRS need to fully utilize their regulatory powers to develop creative solutions to protect the employer provided health benefits that middle class Americans have earned.
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