Why We Need the Cadillac Tax: Good Policy for Healthcare

Scheduled to take effect in less than three years, the Affordable Care Act’s (ACA) so-called “Cadillac tax” is one of the most hotly-debated healthcare issues among presidential hopefuls and legislators alike. Yet media coverage is slim compared to the far-reaching effects the policy is likely to have. The humorously-named component of Obamacare is an excise tax on the most expensive healthcare plans. When the Cadillac tax comes into effect in 2018, companies will face a whopping 40 percent tax on every dollar above a certain threshold they give to their employees through healthcare plans.

Obamacare sets this threshold at $10,200 for individuals and $27,500 for families. To put these amounts into perspective, the average prices of healthcare plans last year were $6,025 and $16,834 for individuals and families, respectively. With these limits, the Kaiser Family Foundation (KFF) estimates that up to 26 percent of employers will be affected by the tax in the first year of implementation alone. Of course, these thresholds need to be changed every year due to inflation. The ACA adjusts the excise tax according to the Consumer Price Index (CPI) – a measure of the inflation faced by the average consumer – plus one percent for the first two years and then CPI alone indefinitely.

This economic jargon is important to understand to take part in the debate, a factor that may be keeping the issue off the common person’s radar. Economists have shown that CPI consistently increases at a slower rate than medical spending does. This means that the Cadillac tax will affect more employers with time; KFF expects the tax to hit 42 percent of companies by 2028. For institutions employing more than 200 workers, that number jumps to 68 percent.

When broken down, the Cadillac tax seems more like a Toyota tax. But don’t run from it just yet. While opponents cite these large percentages as evidence that companies offering non-luxury plans will be harmed, they mask the fact that many employer healthcare plans offered are already lavish. It is useful to consider the policy not as a new tax, but rather as the repeal of unsustainable tax breaks companies have been receiving for years.

Taxing luxurious health benefits may be a blessing in disguise, because employer-provided healthcare goes untaxed. This is the largest tax break of all those given by the US government, and it disproportionately benefits the rich while doing next to nothing for the poor. So, employees have a clear incentive to funnel as much compensation for workers as possible into healthcare plans. This means that precious resources are diverted from wages to fund unnecessary healthcare plans. This lavish healthcare coverage encourages doctors to perform unnecessary procedures, causing costs to rise even further.

Barring the discovery of a viable alternative that could feasibly guarantee health insurance for economically-disadvantaged Americans, this tax is the only option.

In theory, a steep tax on extravagant healthcare will incentivize the redirection of funds back to wages. These wages could still be applied to health-related costs, but could also be used to pay for food, rent, education, and more at the discretion of the worker. Of course, there is no way to guarantee that these dollars will make it safely into the pockets of employees. At the same time, there is no reason to believe that they won’t. One could argue, however, that if employers were going to use this money on something other than compensation, they wouldn’t have devoted it to healthcare plans in the first place. This could help invigorate the growth of relatively flat wages recently. Prominent economists cite health care as “eating away at” wages, which have shown no real growth since the 70s. The redirection of compensation could finally allow for such growth.

There is another practical reason to support the Cadillac tax: We need it to fund Obamacare. Whether or not you support the ACA, the reality is that it is expensive. This new tax is meant to raise $87 billion in vital revenue. Without it, it is unclear where these funds will come from. Some have proposed variations on the Cadillac tax, such as taxing expensive plans progressively, the same way income is handled. This will produce less revenue while discouraging expensive healthcare plans. Barring the discovery of a viable alternative that could feasibly guarantee health insurance for economically-disadvantaged Americans, this tax is the only option.

Despite its clear advantages and necessity, critics remain outspoken against the policy. Interestingly, the issue has garnered no clear partisan split. One prominent opponent is Democratic socialist presidential candidate Bernie Sanders. Hillary Clinton carefully equivocated on the issue before finally coming out against the tax just days ago. On the other end of the spectrum, some Republicans, known to despise the Affordable Care Act, have come out in favor of the policy, citing its inevitability.

Unfortunately, healthcare policy is largely misunderstood due to its technical nature. It is probably in a presidential candidate’s best interest to oppose a seemingly ominous tax that is outside the intellectual stomping ground of the general public. Still, the candidates’ continued demonization of an ultimately positive policy has only served to further obfuscate an already cloudy policy area. The heavy opposition from unions only encourages workers to shy away from a policy that should ultimately better their situation and the US economy. Hopefully, the next president will be able to disseminate clear information on the excise tax regardless of whether it affects Cadillacs or Toyotas.