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June 2019

The "Cadillac Tax": It's Time to Kill this Health-Policy Zombie

Published in Health Affairs, June 18, 2019
https://www.healthaffairs.org/do/10.1377/hblog20190617.795057/full/

The Cadillac Tax is a classic “policy zombie,” retaining support despite a transformed environment. In today’s world, policymakers should incentivize employers to strengthen rather than cut their support for workers’ and dependents’ health insurance. Lawmakers increasingly realize the need to change direction, as suggested by the bipartisan majority of House members and more than a third of the country’s Senators who are now co-sponsoring 2019 legislation that would repeal the Cadillac tax.  Abundant evidence shows the need for this change.

Why does the ACA have a Cadillac Tax?

For decades, health economists have deplored the uncapped tax preference federal law gives to employer-sponsored insurance (ESI). In his landmark 1988 Health Affairs article articulating a vision of “managed competition” that later animated President Clinton’s proposed Health Security Act, Alain Enthoven noted:

“One of the main reasons for the continuing acceleration in health care spending as a share of GNP is that so many people remain in the open-ended cost-unconscious sector in which there is no incentive to contain costs. A recent survey indicated that in 1986 as many as 54.9 percent of employers paid the entire health insurance premium for their employees…”

In enacting the ACA’s Cadillac Tax, policymakers sought, while raising revenue, to curb employers’ perceived incentive to furnish “overly generous” health insurance. As Warshawsky and Leahy explained in an April 2018 Health Affairs article:

“This tax advantage on health benefits makes it attractive to employers and employees to enhance employee compensation through increases in the untaxed benefits, rather than increases in salaries—which are subject to taxation. These conditions may encourage overly generous health coverage, which in turn can lead to overconsumption of health services and contribute to demand pressures that increase health care costs. The Affordable Care Act’s ‘Cadillac tax’ is designed to disrupt this dynamic and increase tax revenue by imposing on employers a 40 percent excise tax on health benefits … that exceed certain threshold values …. adjusted annually for inflation via the Consumer Price Index.”

Originally slated to take effect in 2018, the Cadillac Tax has been delayed twice and is now scheduled for implementation in 2022. The Congressional Budget Office (CBO) estimates that, through 2029, the tax will produce $193 billion in federal revenue. But of that total, employers are expected to directly pay only $58 billion, or 30% of projected receipts. The remaining 70% of revenue results from CBO’s assumption that companies will use their ESI savings to raise taxable wages. CBO projects that the tax’s impact will swiftly accelerate, with annual federal savings shooting up from $6 billion in 2022 to $42 billion in 2029, as the Cadillac Tax produces ever-deeper cuts to employer-sponsored health insurance.

ESI no longer provides overly generous coverage

When Enthoven wrote his seminal article more than 30 years ago, reasonable observers could object to typical ESI as overly generous. Two decades later, some of the policymakers who enacted the ACA took a similar perspective based on data then available, showing the characteristics of employer plans in 2008. Nowadays, few observers would argue that ESI gives most workers and their families excessive coverage, as explained below.

Workers’ ESI costs have grown substantially over time

Table 1 compares coverage described by the Bureau of Labor Statistics’ 1986 analysis, cited by Enthoven, with Kaiser Family Foundation (KFF) survey results for employer-sponsored coverage in 2008 and 2018. Results involve large- and medium-sized firms, with more than 100 or 250 workers for the BLS study (depending on the industry) and more than 200 for the KFF reports.

Deductibles for single coverage skyrocketed over this period:

  • In 1986, the average annual deductible for covered workers was less than $81, in 2018 dollars. Two-thirds of workers receiving ESI (65%) had no deductibles for single coverage (table 1). Among the 35% with deductibles, the average annual amount, in 2018 dollars, was less than $230. For workers as a whole, the average deductible was thus less than $81 (.35 x 230 =80.5).
  • By 2008, that average rose to $553, according to KFF totals released in 2018.
  • As of 2018, KFF’s estimate for the average single deductible for all covered workers reached $1,355—more than twice the average 2008 deductible known to policymakers who passed the ACA.

From 2008 to 2018, deductibles for family coverage rose even faster. In 2008, 56% of workers had a family deductible, which averaged $1,140 (in 2018 dollars). But 44 percent of covered workers had no family deductibles at all. Putting the two groups together, the average deductible, in 2018 dollars, becomes $638 (.56 x 1140 = 638).  By 2018, just 14% of workers had family coverage without any deductible. Among the 86% who were charged a deductible, the average amount was $2,821. As a result, the average for all enrollees reached $2,426 (.86 x 2821 = 2426), or nearly four times the average family deductible in 2008.

Using that same approach to averaging costs among all covered employees, including those with and those without charges, workers’ average annual premium costs for single and family coverage, respectively, grew (as denominated in 2018 dollars) from $166 and $741 in 1986, to $804 and $3,325 in 2008, to $1,135 and $6,781 in 2018 (table 1). Of course, differences between BLS and KFF methodologies mean that these estimated changes from 1986 to 2008 show the approximate magnitude of ESI transformation over that 22-year period rather than provide a reliable guide to specific dollar amounts.  

Table 1. Health Insurance Coverage Offered by Medium- and Large-Size Companies: 1986 vs. 2008 vs. 2018 (in 2018 dollars)

  1986 2008 2018
Employee payment of health insurance premiums Percentage of enrolled workers where firm pays full premium costs Single coverage 54% 10% 6%
Family coverage 35% 4% 1%
Average annual employee contribution at firms not paying full premium costs Single $360 $893 $1,207
Family $1,140 $3,464 $6,781
Deductibles Percentage of enrolled workers without deductibles Single 65% 44% 15%
Family n/a 44% 14%
Average deductible among those subject to any deductibles Single Under $230* $726 $1,355
Family n/a $1,140 $2,821

Sources: Bureau of Labor Statistics (BLS) 1987; Kaiser Family Foundation (KFF) 2008 and 2018. Note: Deductible calculations for 2008 and 2018 are based in part on weighted averages of health plan enrollment among plan types for firms with 200 or more workers, as reported by KFF. BLS data for 1986 varied the minimum surveyed firm size between 100 and 250 employees, depending on the applicable industry. BLS did not report on family deductibles in 1986. The table trends forward 1986 and 2008 amounts to July 2018 dollars based on the Consumer Price Index for all Urban Consumers, using the BLS inflation calculator.

*The BLS report did not provide an average deductible, but it did show that more than 55% of employees with deductibles had annual amounts of $100 or less, in 1986 dollars, or $230, in 2018 dollars. Nearly two-thirds (64%) had deductibles of $150 or less.

According to Commonwealth Fund surveys, average individual-market deductibles as a share of median U.S. income jumped by 78% from 2008 to 2017, rising from 2.7% to 4.8% of median income. The share of ESI enrollees classified as “underinsured” because of high out-of-pocket costs and deductibles more than doubled from 2005 to 2018, climbing from 12% to 28%. Among ESI enrollees whose earnings were less than twice the poverty level, fully 57% were underinsured in 2018.

Inadequate ESI is now a serious national problem

In late 2018, the Kaiser Family Foundation and the Los Angeles Times surveyed workers about the financial security and access to care that ESI provided them and their families. The results were disturbing. Among ESI enrollees as a whole, who comprise 60% of U.S. adults under age 65:

  • Two out of five ESI participants (40%) reported difficulty affording health care or insurance during the past 12 months, typically because of high out-of-pocket costs. Among those experiencing such problems, nearly two-thirds (65%) cut their spending on food, clothes or other household items, and nearly half (46%) used up all or most of their family’s savings to pay for care.
  • Slightly more than half (51%) of all ESI enrollees reported that they or a family member skipped or postponed needed health care in the past 12 months because of cost.

Limitations to current ESI took a particularly serious toll on low- to moderate-income families and people with chronic conditions:

  • At least three out of every five ESI enrollees who earned less than $40,000 in annual income (62%) or who had a chronic condition (60%) skipped or postponed needed care because of cost during the past 12 months.
  • Nearly half of all ESI enrollees with chronic conditions (49%) had difficulty affording care or insurance. More than a third (35%) had to cut back spending on food, clothes, or household items. Fully one in four chronically ill ESI beneficiaries (26%) used up all or most of their family’s lifetime savings to pay for care.
  • When people with chronic conditions received high-deductible employer-based coverage, the results were particularly grim. Fully three out of four (75%) chronically ill people facing individual deductibles of $3,000 or more avoided or delayed necessary care because of cost during the past 12 months, even though such steps can place chronically ill people’s health at grave risk.

The Cadillac Tax moves our country in exactly the wrong direction

Even before taking effect, the looming Cadillac Tax accelerated longstanding trends for employers to increase deductibles and other out-of-pocket cost-sharing. Once it activates, the tax is likely to spur further cuts to health benefits. A recent analysis in Health Affairs found that, by 2025, the Cadillac Tax would affect roughly one out of every four workers receiving ESI—23.5% of those with single coverage and 27.9% of people enrolled in family plans. The workers most likely to be affected included union employees, teachers, people living in the Northeast or West, and high-wage workers.

The basic import is clear (even though the analysis assumed the tax’s original 2018 effective date, so the projected impact will likely not occur until several years after 2025). The Cadillac Tax will incentivize a large and ever-growing share of employers to reduce the generosity of health insurance, further raising deductibles and other out-of-pocket costs.  The non-partisan Congressional Research Service thus found that the Cadillac Tax “could lead to an overall decline in the quality of health services financed by private insurance,” with businesses cutting their spending on employee health benefits by $47.6 billion to $69.2 billion in 2025 alone.  

Some Cadillac Tax supporters argue that firms could redirect all of their ESI savings into higher wages, as assumed by CBO. Unfortunately, there is no guarantee that this will actually happen on a wide scale. Paul Fronstin, one of the country’s leading ESI experts, recently observed that, while many studies show employers cutting wages when their health insurance costs rise, almost no research has examined how employers spend their gains when insurance costs fall.  Rather than raise workers’ pay, businesses could use their health insurance savings to finance stock buy-backs, mergers and acquisitions, dividends, or other steps that achieve corporate strategic goals more effectively than wage increases.  

And when companies use their health insurance savings to boost earnings, the resulting raises are unlikely to reach the families most affected by insurance cuts—namely, low-wage workers and people with chronic illness. Crucially, federal law forbids companies from offering more generous health benefits to higher-wage workers than to lower-wage workers. No such constraint governs pay. The money a company saves from cutting health benefits for all employees and dependents could thus be channeled into higher wages for whatever subset of employees is most valued by the firm’s leadership, such as corporate executives or highly skilled workers in very competitive labor markets.

Another argument to support the Cadillac Tax notes that the ESI tax exclusion is regressive. The exclusion’s dollar value rises with income because, compared to lower-wage workers, better-paid workers have higher marginal tax rates, are more likely to receive ESI, and may be enrolled in plans with comparatively generous benefits. It does not follow, however, that higher-income workers and their families will be the ones who suffer the most if the Cadillac Tax triggers further ESI cuts. In truth, the healthy and the wealthy have the greatest ability to fill the gaps left when their employers retreat from coverage sufficiency. And as noted earlier, high earners within affected companies may be more likely than other employees to receive whatever wage increases result from ESI savings. Unlike most other forms of compensation, ESI has sharp legal limits on inequality. If ESI becomes less generous, total compensation gaps between the best-paid and worst-paid employees at U.S. companies could grow rather than shrink.

As an empirical matter, low-wage workers and people with chronic illness have been the ones experiencing the greatest harm from recent decades’ ESI erosion. That troubling pattern seems unlikely to change if the Cadillac Tax further hastens the erosion.

Conclusion

Economists’ critique of the ESI tax exclusion retains some theoretical validity today. Among other problems, the exclusion encourages employers to devote worker compensation dollars to health insurance rather than wages, for reasons unrelated to workers’ preferences and needs. Exempting the value of health benefits from progressive taxation also raises equity concerns.

That said, this is a moment to resist the siren song of economic theory. Millions of ESI beneficiaries face a grim and darkening reality of increasingly inadequate coverage, especially for low- to moderate-income workers and people with chronic illness. Now is not the time to encourage employers to make further health care cuts. Instead, policymakers should focus on measures that provide families with more rather than less comprehensive health benefits.

The Cadillac Tax was born in a health benefits universe that has long since vanished. Entombed in statute, the tax continues shuffling forward towards implementation. It is finally time to kill this health policy zombie