tax.com: Featured Articles: Three Practical Tax Increases to Fund Healthcare Reform

Featured Articles

Three Practical Tax Increases to Fund Healthcare Reform

By all appearances, members of Congress are suffering physical pain in their effort to fund President Obama's $635 billion "down payment" on expanded healthcare coverage. If Congress follows Obama's lead, about half of the funding will come from cost savings and cutbacks in government healthcare spending. The other half will come from tax increases. That second half is what this article is about.

After sitting through the Senate Finance Committee's roundtable discussion and reading all the participants' statements (see the list at the end of the article), we think the following three tax proposals, in combination, could provide an economically desirable and politically realistic way of raising the needed $300 billion.

Part 1. Increase the tax on alcoholic beverages.

Some participants at the roundtable discussed taxing soda pop and other "sugary beverages." This latest version of the snack tax is not an attractive option. It would be too complicated to administer, and the public would quickly perceive its unfairness, because some junk foods would be arbitrarily taxed while others get away scot free.

Other participants suggested the old standby: yet another cigarette tax increase. But even the most avid haters of secondhand smoke will have to admit the tax on cigarettes is getting ridiculous. And with each increase, the incentives for smuggling grow larger. The national average retail price for a pack of cigarettes is just under $5. The average state tax per pack is $1.23. And it was just this April that the federal cigarette tax rose 62 cents -- to $1.01 per pack -- to pay for expanding health insurance provided to children.

Between the states and the feds, government is already taxing tobacco way out of proportion to its social cost. (See W. Kip Viscusi, "Tobacco Taxes," in The Encyclopedia of Taxation and Tax Policy, Urban Institute, 2005.) This means there is no clear economic justification even for maintaining the tax at its current level, much less increasing the tobacco tax.

In contrast to the first two, the third option on the sin tax menu makes a lot of sense: a tax increase on alcohol. Congress has not increased the tax on alcoholic beverages since 1990, and inflation has eroded the tax take by 37 percent. The federal government collects a little less than $10 billion a year in alcohol taxes. Just restoring the taxes to 1990 levels would raise $30 billion over 10 years.

And the current level of tax is far below the level that can be justified by the social costs of drinking. According to a group of leading economists, including four Nobel laureates, the annual social costs of alcohol consumption are $185 billion. (See "Economists' Declaration on Federal Alcohol Excise Taxes," May 2005, available at http://www.cspinet.org/new/pdf/petition-alcohol.pdf.) As a result of these findings, the group supports an increase in the alcohol tax.

Measured by alcohol content, hard liquor is taxed more heavily than wine and beer. A budget option offered by the Congressional Budget Office would raise the federal tax on spirits by 19 percent. And then to equalize taxes by alcohol content, the proposal would raise the tax on wine by a factor of 3.3 and the tax on beer by a factor of 2.5. Under this option, the federal excise tax on a fifth of whiskey would rise from about $2.14 to $2.54. The federal tax on a six-pack of beer would rise from 33 cents to 81 cents, and the tax on a bottle of wine would increase from 21 cents to 70 cents. The CBO estimates this proposal would raise federal revenue by $60 billion over 10 years.

Part 2. Limit the tax rate at which itemized deductions reduce
tax liability to 35 percent.

To help pay for healthcare, Obama proposed limiting the value of itemized deductions like those for mortgage interest and charitable contributions to 28 percent. This proposal would raise the hefty sum of $267 billion over 10 years. Congress hates the idea, and by all accounts it has no chance of passing (which is why Congress is exploring all these other options). The most common complaint is that the reduced incentive for charitable giving would hurt nonprofits.

But wait a minute -- let's think a little more about this. Obama is also proposing restoring the top individual tax rate to 39.6 percent. Note that in the likely case that the rate increase passes without the deduction rollback, the incentive to make contributions and take out mortgage loans will actually increase -- and instead of being worse off, as they now fear, charities would actually benefit from Obama's tax program.

Table 1. Estimated Revenue Gain From Various Proposals To Cap the Employer-Provided Healthcare Exclusion (in billions of dollars)
-----------------------------------------------------------

No exclusion

for amounts

above average

premium -- but

cap applies No exclusion No exclusion

No exclusion only to for amounts for amounts

for amounts families with above 75th above 90th

above average income over percentile percentile

premium $125,000 premium premium

-----------------------------------------------------------

A. Estimates by Tax Policy Center (2010-2019)

No indexing $1,082 -- -- $778

CPI indexing $848 -- -- $531

Index to cost
of health
insurance $165 -- -- $41

B. Estimates by Prof. Jonathan Gruber at MIT (2012-2019)

CPI indexing $500 $340 $330 --

Index to cost
of health
insurance $360 $240 $220 --

C. Estimates by the Lewin Group (2010-2019)

CPI indexing $585 -- $362 $220
-----------------------------------------------------------

With the individual rate increase, Congress could keep marginal incentives for charitable giving (and spending related to other deductible expenses) unchanged by limiting the tax benefit of itemized deductions to 35 cents on the dollar -- the maximum available under current law. Robert Greenstein of the Center on Budget and Policy Priorities made this suggestion in his statement to the Finance Committee. This watered-down version would probably raise a small fraction -- perhaps 20 percent -- of the $267 billion estimated for the full Obama proposal.
Part 3. Limit the exclusion for employer-provided health
benefits, but only for the most expensive plans.

The exclusion for employer-provided health insurance is a huge, blobby subsidy at the intersection of heathcare and tax policy. It injects one quarter of a trillion dollars per year of tax benefits into the nation's healthcare system. After Medicare and Medicaid, it is the third-largest government healthcare program. And it is the largest tax expenditure.

Despite its enormity, the exclusion is available only to employees with employers offering healthcare. But for these lucky individuals and their families, it is open-ended and unlimited.

The politics of the exclusion can be a little tricky. Big business and big labor are adamantly opposed to any cutback in the exclusion. They are joined by many prominent members of Congress. Among them is House Ways and Means Committee Chair Charles B. Rangel, D-N.Y. During the presidential campaign, Republican candidate John McCain of Arizona proposed repealing the exclusion and replacing it with a more equitably distributed tax credit available to all, irrespective of their employment status. Candidate Obama loudly attacked McCain's proposal. Although not ready to renounce the position he took during the campaign, the White House is signaling that the president could be open to some adjustment of his views if Congress proposed reforming the exclusion.

With battle lines so scrambled, any attack on the exclusion is fraught with danger. But there are some glimmers of hope for a cap. With Congress thirsting for cash, the exclusion has become a tempting reservoir of revenue. And besides, the logic in favor of capping the exclusion is compelling. Why should the government subsidize expensive heathcare packages for wealthy individuals when it is desperately short of cash needed to expand coverage for those who have no health insurance at all?

At the Finance Committee roundtable, more than half a dozen policy experts -- both conservative and liberal-leaning -- criticized the exclusion and urged Congress to cap it. Their complaints: It helps the rich more than the poor; it does not help the unemployed and workers whose employers don't offer health insurance; it fuels growth in healthcare costs; it inefficiently allocates resources inside the health sector; and it inefficiently draws resources into the healthcare sector and away from other productive sectors of the economy.

There are two ways to cap the exclusion. The first is by income. Individuals with income above a certain level would be allowed to exclude only a fraction of employer-provided healthcare expense from income and payroll tax, with the fraction declining as income rises.

The second way is by the value of employer-provided benefits. Employees could be restricted to exclude no more than a specified dollar amount of health benefits from taxable wages each year. If they purchase health plans with greater benefits, the difference between a more generous plan and the cap could be subject to income and payroll taxes.

The cap amount most often discussed is the average cost of employer-provided health insurance. That means only the health insurance costs in excess (if any) of the national average would be subject to tax. The cap could also be set higher, sparing a larger fraction of the workforce, at the cost to the government of reduced revenue. For example, the cap could be set to the employer cost level dividing the bottom 75 percent of employees from the top quarter -- or at the level dividing the bottom 90 percent from the top 10 percent.

Once these levels were set for a base year -- for example, 2009 -- they would need to be indexed to inflation to prevent a massive increase in taxable employer-provided health benefits over time. A big question is which index to use. If it is the commonly used Consumer Price Index, the cap will capture an increasingly larger share of the workforce if, as expected, healthcare costs continue to rise at a rate significantly faster than inflation. To remedy this, the cap could be indexed to an index of health insurance costs.

In the totally unrealistic case of the exclusion being completely repealed, the government would gain a whopping $3.5 trillion over 10 years, according to the Tax Policy Center. We need less than one-tenth of that to achieve our overall tax target of about $300 billion. In combination with the two proposals above, we would need between about $100 billion and $200 billion -- depending on the final parameters of an alcohol tax increase and deduction limit.

That type of money is plausible under a variety of reasonable possibilities, as shown in the table on the previous page. According to estimators at the Lewin Group, Congress could raise $220 billion over 10 years by capping the exclusion at the premiums paid by those at the 90th percentile and then indexing that amount to the CPI. Prof. Jonathan Gruber at MIT estimates a revenue gain of $240 billion if the cap is set at the current average premium cost, indexed to healthcare costs, and then applied only to families with incomes over $125,000. And reading between the lines of the Urban-Brookings Tax Policy Center estimates, it appears $200 billion would be easily attainable with a 90th percentile cap indexed with some hybrid index that grows faster than the CPI but more slowly than health insurance costs.

The most troublesome aspect of any proposal for a uniform nationwide cap on the exclusion is that many employer-provided plans are expensive not because benefits are generous, but because some employees are stuck in high-cost plans. Health insurance premiums vary greatly across local markets. A uniform cap would disproportionately burden employees in high-cost regions who are getting the same (or even fewer) benefits than employees in low-cost regions. Similarly, employees in plans covering an older workforce pay more for the same coverage than employees who are part of a younger workforce.

Adjustments could be made to the cap based on geography and age, but this would add a thick layer of complexity. Although it is hoped and expected that healthcare reform will level off regional disparities in healthcare costs, it is hard to believe legislators from high-cost areas could ever agree to a cap without some sort of adjustments to a cap that takes these disparities into account.

Conclusion

We wanted to show readers one way Congress could use taxes to solve a significant part of its healthcare financing problem. The plan suggested here combines a significant alcohol tax increase with modest, targeted cutbacks to itemized deductions and to the exclusion for employer-provided healthcare. Others with more imagination and bigger computers can surely devise a dozen others. Any $300 billion tax increase will be tough, but it hardly seems implausible.

About Us | Contact Us | Privacy | Terms of Service