Study Suggests Tax Changes Could Adversely Affect Employer Health Coverage

September 17, 2007 ( - A new study from the Employee Benefit Research Institute (EBRI) suggests proposals to change the tax treatment of health insurance could end employment-based heath coverage as it currently exists.

In a news release, EBRI said, of the various options to change the way health benefits are taxed, the proposed “tax cap” on the health insurance exclusion that workers currently receive is most likely to cause the end of employment-based health benefits.

EBRI explained the change would be likely to prompt younger and healthier workers to drop out of the employment-based system, causing adverse selection in the remaining pool of older and less healthy workers, thereby resulting in a so-called “death spiral” that makes employment-based group health insurance unsustainable.

Although the current Congress is expected to ignore President Bush’s 2007 State of the Union proposal for fundamentally changing how health insurance is taxed, his concept seems certain to survive the end of his administration, said EBRI in the news release. The Institute pointed out that bipartisan tax plans have been introduced in the Senate, and several 2008 presidential candidates have proposed overhauling the taxation of health benefits.

The study in the September 2007 EBRI Issue Brief, available at , examines in detail three proposals to change this tax treatment, who would be affected, and how:

  • A tax cap: “Capping” employers’ tax deductions for health coverage, and/or workers’ exclusion for health care benefits, could mean the end of employment-based health benefits. A tax cap would mean a tax increase for some individuals, and the tax increase could be driven by health status and geography more than it is driven by the comprehensiveness of the insurance.
  • Tax caps and cost containment: A cap on workers’ exclusion for health insurance probably would not have much impact on the comprehensiveness of health benefits, at least initially. Over time, the impact of the cap on the tax exclusion should grow as long as insurance premium growth exceeds overall inflation, but it could be many years before the higher taxes are a large enough burden to drive people toward less comprehensive benefits.
  • Tax credits: The ability of a tax credit to reduce the uninsured population depends heavily on several key design issues, such as the size of the tax credit relative to income and income levels overall. Previous research has shown that even very generous tax credits may not be large enough for a major portion of the low-income population to purchase health insurance.

According to EBRI, the most recent data show that about 62% of workers and their dependents (161.7 million individuals under age 65) had some form of employment-based health benefits, while about 7% (17.7 million) bought insurance directly from an insurer, and 18% (46.5 million) were uninsured. Currently, employers can deduct without limit the cost of health insurance coverage they provide to their workers as a business expense and the value of the health insurance coverage workers receive from their employers is excluded without limit from their taxable income.

The EBRI study said at least two factors are driving calls to change the tax treatment of health benefits. The first is a longstanding debate over whether employers should be encouraged to provide health insurance with special tax preferences, or whether the emphasis should be on an individual market and individual choice. Secondly, as pressure grows to deal with long-term deficits and the pending insolvency of Social Security, Medicare, and Medicaid, fundamental tax reform is likely to find its way onto the national agenda as a big potential target for raising revenue in the future.