Ever since President Obama raised the idea of taxing health care benefits, I’ve been asked what I think about the plan. Specifically, I’ve received a number of emails which more or less ask three questions:
- How would it work?
- Do I think it’s fair?
- Do I like it?
I’m happy to oblige. But first, some history.
This idea of taxing health care benefits is nothing new. In fact, Senator John McCain put forth a similar proposal when he was running for President. At the time, the idea was widely criticized as damaging to working Americans. But, of course, even last summer, most Americans were blissfully (or perhaps not so much) unaware of the economic crisis that was brewing.
Jump ahead to today’s economic climate. Unemployment is up. Tax revenue is down. Government expenditures are up. The percentage of employers offering full benefits, including health insurance, is down.
And suddenly, that idea from more than a year ago doesn’t look so bad to many Congressional officials. Go figure.
So now, the proposal is not only back on the table, it’s back in a big way: it’s actually making its way through Congress.
So what’s the basic idea? Put simply, it would characterize employer-provided health insurance benefits as taxable. So, for example, to the extent that your employer pays a portion – or all – of your health insurance benefits, that portion would be reportable as taxable income on your form W-2 at the end of the year. To the extent that you pay a portion – or all – of your health insurance costs yourself, that portion is not taxable.
Sounds pretty simple, right?
That’s the answer to the first question.
Now, to the second: do I think it’s fair?
Actually, I do. Health insurance is a massive benefit not provided to all employees. It’s a perk. And a substantial one. If taxed, health care benefits are estimated to be worth nearly $246 billion in revenue – that’s nearly ten times the entire revenues of the state of Pennsylvania alone.
Let’s compare two employees, each nearly identical. One employee makes $50,000 per year and receives health insurance benefits of $4,700/year paid by her employer. The other employee makes $50,000 per year and pays her own health insurance costs of $4,700/year.
(Those figures are based upon the following statistics: In 2008, the annual premium for an employer health plan covering a family of four averaged nearly $12,700. The annual premium for single coverage averaged over $4,700. Median income in the US was approximately $50,000.)
What’s the difference?
Assuming a 20% tax rate (for easy math), here’s the breakdown:
The first employee has $4,700 health insurance benefit tax-free and walks away with $40,000 in cash ($50,000 – 20% tax on $50,000).
The second employee walks away with $35,300 in cash ($50,000 – 20% tax on $50,000 = $40,000 – $4,700 in health insurance). Even worse, the employee may not be able to fully deduct the cost of the health insurance because she must first satisfy the medical expenses floor and then only if she itemizes. And, complicating matters, the cost of that insurance is likely much higher for the employee – individual rates are statistically much more expensive than corporate rates (I can personally attest to this – my husband and I save several hundreds of dollars per month by buying coverage through our firm).
Is that fair?
If employees were taxed on the health care benefit, here’s the breakdown:
The first employee now walks away with $39,060 ($50,000 – 20% tax on $54,700, the cost of salary plus benefits).
The second employee still walks away with $35,300 ($50,000 – 20% tax on $50,000 = $40,000 – $4,700 in health insurance).
Remarkably, in both examples, the first employee is better off than the second employee. In the second example, however, there’s a wee bit more parity. So, do I think taxing health benefits is fair? Yeah, I do. Because getting health insurance benefits tax free is, quite simply, the same as being paid more to begin with.
But almost everyone gets health insurance as a perk, right?
Actually, no. Nearly 80% of all businesses in the US are self-employed. (Source: US Census) That means that at least 80% of the US workforce provides their own health care benefits; it is not a company-sponsored benefit. Additionally, most small businesses are overwhelmingly sole proprietors, partnerships, LLCs, LLPs, or S corporations, each of which has restrictions on tax deductibility for health insurance.
Of the remaining businesses in the US who report having paid employees, 78% have fewer than 10 employees. (Source: US Census) The US is still very much driven by small business. And small business is paying a lot for health care. Many small businesses have been priced out of quality employees because of the cost of health care. Interestingly, making health care insurance taxable would make compensation packages as between smaller and larger businesses much more balanced.
So do I think taxing benefits is a fair proposal? Actually, I do.
Do I like it? That’s a totally different question. I’m not sure. I like the idea of it in theory but I think that the imposition of the tax would be akin to a slap in the face for many taxpayers. As a society, we’ve come to rely on those benefits as something that we’re entitled to, a perk that we deserve, something that no one should be able to touch. I think of it like the mortgage interest deduction, something that inherently and unfairly benefits a disproportionately small percentage of the population but something that US taxpayers have come to rely on when making lifestyle choices. The imposition of a tax on health care benefits might be an unexpected and unwelcome addition for taxpayers who have made choices about employment based on a benefits package that, up until recently, would have been tax advantageous.
It’s a politically dangerous – and potentially complicated – proposal. I happen to think it’s a step in the right direction, though. What do you think?
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