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Senate Finance Panel Ponders Toolkit for Tinkering with 'Exclusion'

By John Reichard, CQ HealthBeat Editor

May 14, 2009 -- Some of the leading thinkers in health care offered Senate Finance Committee members a range of options for taxing health insurance benefits this week, a potentially big pot of revenues for covering the uninsured in health overhaul legislation that may move through Congress later this year.

The tax hike options they outlined are referred to in technical terms as "capping the exclusion," which refers to a tax law provision that excludes employer-paid health insurance premiums from an individual employee's taxable income. Several analysts at a Senate Finance Committee "roundtable" Tuesday on financing coverage of the uninsured urged changes to the exclusion, despite arguments that revisions would be unfair to certain employees or too complex to administer.

Committee Chairman Max Baucus, D-Mont., said he opposes elimination of the exclusion, but wants to look at modifications.

Eliminating the exclusion in calculating income and payroll taxes would raise $3.5 trillion over 10 years, according to an estimate by the Tax Policy Center, a joint program of the Urban Institute and the Brookings Institution. Leonard E. Burman, the director of the center, told the roundtable, however, that elimination would be undesirable "because tens of millions of Americans would likely lose their health insurance."

But if the exclusion wasn't eliminated but was capped at the average cost of health insurance in 2009, revenues from income and payroll taxes would rise by about $1.1 trillion over 10 years, Burman said. That's in line with some estimates of the cost of universal coverage. He estimated the 2009 average cost of single coverage at $5,370, of single coverage plus one other person at $10,227, and of family coverage at $13,226.

With the cap set at that level relatively few people would pay higher taxes at first, Burman said—only 30 percent of households would pay higher taxes in 2010. But because health care costs grow fast, virtually all households with employer-sponsored health coverage would be paying higher taxes by 2019, he noted.

If the cap were adjusted each year to rise with the consumer price index, an additional $848 billion in revenues would be raised over 10 years. Were it adjusted to rise with health care cost inflation each year, $165 billion would be raised over 10 years.

"A less draconian variant would be to cap the . . . exclusion and deduction for the self-employed at the 90th percentile for premiums," Burman said. If this option were used without indexing it for inflation, $500 billion would be raised over 10 years, he said. Were a cap at the 90th percentile indexed to rise each year by the consumer price index, it would raise $336 billion. And if it were indexed to rise by medical cost inflation, it would raise $26 billion over 10 years.

Jonathan Gruber of the Massachusetts Institute of Technology estimated that a cap set to tax only the top quarter of the most expensive plans would raise $330 billion over 2012–2019 if indexed to rise with the consumer price index and $220 billion over that period if indexed for premium growth.

Gruber said that another approach might be to cap the exclusion at the typical premium level for employer-sponsored insurance but only for families with incomes above $125,000 per year. That would raise $340 billion over 2012-2019 if the cap were indexed to the consumer price index or $240 billion if indexed to premium growth, he said.

Critics say that a cap would be unfair in that it would affect more people who live in areas with high health care costs, who work for small firms (which in general must pay higher premiums), or are self-employed, older, or in poor health since they all tend to pay higher premiums. "It would be feasible, although not easy, to adjust the caps for all these factors," said Burman. "One option might be to set up a publicly sponsored market, like the Federal Employees' Health Benefits Program, where anyone could purchase inexpensive insurance and tip the cap to the cost of such insurance in each market."

Gruber asserted that the cap could be set higher in firms with older workers and possibly lower in firms with younger workers, and adjusted higher in high-cost states and lower in lower-cost states. "Some have argued that it would be administratively infeasible to reduce this tax subsidy," he noted. "This is simply wrong," he asserted.

But groups representing employers object to capping the exclusion. James Klein, president of the American Benefits Council, said in testimony before the roundtable that "it would be a mistake to limit or otherwise undermine the exclusion." He added that "raising taxes on those who participate in health plans is not the way to solve the health care system's ills." He said it would be difficult if not impossible to design a cap that did not result in tax inequities and require "a costly set of valuation rules for employers and workers."

And labor also objects. Gerald Shea, assistant to the president of the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO) said capping the exclusion would be "a step in the wrong direction" and "threatens to disrupt the primary source of health coverage and financing for most Americans."

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