WASHINGTON—For 60 years, American workers have received job-sponsored health-care benefits that are excluded from income and payroll taxes, but now they're in danger of taxation.
An odd coalition of groups from both the right and left wants to tax those benefits, and a special presidential commission is weighing whether to recommend ending their tax exemption when issuing its report Sept. 30 on how to overhaul the tax system.
On Capitol Hill, aides to tax-writing committee chairmen said ending the exemption had become "background chatter" in both chambers of Congress, where lawmakers are meeting privately in search of consensus on how to close expected funding gaps for Social Security and Medicare.
Today's system of employer-provided health care dates to World War II, when the federal government imposed wage caps to help the wartime economy. Unable to offer higher wages to attract scarce workers, companies competed for them by offering health insurance.
The war ended, but job-based insurance stuck. By the mid-1950s the Internal Revenue Service code favored it. Companies were allowed to deduct the costs of employee health-care plans from their taxable income. For employees, those often-generous benefits were separate from taxable wages.
Left-leaning advocates call for ending the tax exclusion for job-sponsored health benefits in the name of fairness. They think the benefits are an invisible tax break for wealthier Americans that's unavailable to poorer ones, who generally don't get job-based health insurance.
"The tax break is regressive because people at the lower-income brackets get less benefit. It does just the opposite of what it should," said David Kendall, a senior health-policy analyst at the Progressive Policy Institute in Washington, a research center for the centrist Democratic Leadership Council. "It promotes coverage for people who can already afford it."
Census Bureau data show that 82 percent of Americans who earned more than $75,000 last year had job-sponsored health plans excluded from taxation, but only 23 percent of Americans who made less than $25,000 did.
Americans without job-based health insurance must pay their medical bills out of pocket or purchase their own insurance, and in both instances they generally are unable to deduct those costs from their taxes. President Bush hasn't called publicly for ending the tax exclusion, but he promotes Health Savings Accounts, enacted into law last year, which allow qualifying Americans to set aside money for health-care expenditures that can be credited against income taxes.
Some right-leaning advocates think the tax exclusion for job-sponsored health benefits should end because it distorts the free market. The Heritage Foundation, a conservative policy-research center, says the exclusion leaves consumers in the dark about the real costs of health care, leading them to make uninformed decisions that ripple through the health-care economy, driving up costs.
"The idea of an employer determining what is best for them is increasingly untenable," said Robert Moffit, the director of Heritage's Center for Health Policy Studies.
Advocates on left and right agree on this: Ending the tax exclusion should be accompanied by a new national tax-credit system for health care.
Tax credits would exempt health plans from taxation up to a set dollar limit. Employers would put price tags on the benefits they provide to employees—many already do this to remind workers why wages aren't rising—and anything above the government-set limit would be treated as taxable income. This would allow the taxation of so-called Cadillac health plans, the generous ones that cover everything from fancy eyeglasses to hair transplants.
"The mechanics of doing it don't have to be revolutionary," said Mark Pauly, an expert on health-care costs at the University of Pennsylvania's Wharton School. "The main problem now is that the exclusion makes expensive insurance look cheap."
The chairman of the tax-writing House Ways and Means Committee, California Republican Bill Thomas, has repeatedly criticized the exclusion of health plans from taxation. Any restructuring of Medicare, Social Security or the federal tax code must go through his committee. Changes in all three areas are being debated in his committee and elsewhere in Congress.
Earlier this year, the Congressional Budget Office, the legislature's analytical arm, estimated that eliminating the tax exclusion for employers and employees for health-care benefits could raise $195 billion by 2010, and $705 billion through 2015.
If employer-provided life insurance were treated as taxable income, that would raise another $9.7 billion through 2010, and $22.4 billion through 2015.
While those numbers may appeal to lawmakers looking for ways to close a funding gap, few people would welcome being taxed.
"The economics of it are easier than the politics," said Jack Meyer, the president of the Economic and Social Research Institute in Washington, which champions ending the exclusion.
Little is accomplished on health care in Washington without the blessing of the AARP, the powerful lobby for older Americans, and it opposes ending the exclusion.
"To remove the exemption for health benefits would be a significant tax increase on tens of millions of Americans," said David Certner, AARP's federal affairs director.
AARP is open to capping the value of the exclusion provided there's a direct tradeoff benefit for older Americans, especially those ages 55 to 65 who've lost job-sponsored health insurance and are too young to qualify for Medicare, the federal insurance program for retirees 65 and older.
"We would certainly be willing to look at reasonable limits if that money would be plowed back into helping the uninsured," Certner said.
In 2003, 45 million Americans lacked health insurance, census data show. The number of uninsured could be lowered sharply by ending the exclusion and using the new tax revenue to create subsidized insurance for those without job-based coverage, advocates said.
"This really needs to stay within the health sector, to help fix some of the problems we have been dealing with for several decades," said Grace-Marie Turner, the president of the Galen Institute, a Virginia-based health-policy group.
For more information online, go to:
_ The President's Advisory Panel on Federal Tax Reform, March hearing, testimony under Tax Treatment of Families, at www.taxreformpanel.gov/meetings. Click on the one for March 23, 2005.
_ www.healthaffairs.org. Use its Quick Search function to search for "exemption," which will turn up the report "The Cost of Tax-Exempt Health Benefits in 2004."
(c) 2005, Knight Ridder/Tribune Information Services.
GRAPHIC (from KRT Graphics, 202-383-6064): HEALTHTAX
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