June 16, 2009

Why Won't the Obama Administration Accept Taxing Employer-Paid Health Premiums?

Barack Obama's fiscal policy platform as a presidential candidate was hardly a profile in courage, but he had his moments. This, however, was not one of them:
"For the first time in American history, [John McCain] wants to tax your health benefits. Apparently, Senator McCain doesn’t think it’s enough that your health premiums have doubled, he thinks you should have to pay taxes on them too. That’s a $3.6 trillion tax increase on middle class families. That will eventually leave tens of millions of you paying higher taxes. That’s his idea of change."
This was a fairly unprincipled thing to say, and begged the question: why shouldn't employer-paid health care be taxed? Obama never gave us an argument for this beyond the idea that it would be a "middle class" tax hike. In the end, you got the sense that he was saying this not because he believed it would be a bad idea to tax employer benefits, but because it was a good soundbite for him and allowed him to blur the distinction between the stereotypes of the tax-happy Dem and the tax-averse Republican.

One could hope that a year later, when the full extent of our fiscal crisis had become more apparent, the Obama administration would be able to quietly tiptoe away from this position. And Obama has indicated his openness to the idea of taxing employer paid health care like the income it is. But then along comes V-P Joe Biden on Meet the Press last Sunday:
MR. GREGORY: Will the president sign a bill that taxes healthcare benefits for employees?
VICE PRES. BIDEN: We made it clear we do not think that is the way to go. We think that is the wrong way to finance this legislation.
MR. GREGORY: So if the bill comes with that...
VICE PRES. BIDEN: But--no, no, no.
MR. GREGORY: ...the president wouldn't sign it?
VICE PRES. BIDEN: I didn't say that. I said when the bill is going to come, this is the most--this is going to be one of the most comprehensive changes in law since Medicare in the beginning. We'll have to see what the whole bill says. But we made it clear we do not believe you should be taxing, taxing the benefits that people receive through their employers now.
Once again, though, the question is: why take this position? Is there a principle behind it?
There's an easily-stated and compelling rationale for the opposite stance, treating employer-paid health care as taxable income: as Citizens for Tax Justice noted in a 1996 report, it's hard to see "why a person who pays cash for insurance should be taxed more heavily than another person who gets insurance as a fringe benefit (and accepts lower cash wages)."

Put more concretely, if worker A earns $50,000 a year and buys her own health insurance, while worker B gets $45,000 of salary and $5,000 of employer-paid health insurance, the two workers' incomes should be thought of as basically identical. But our tax system gives a preference to the worker who's accepted some of her income in the form of employer-provided health insurance.

The fact that Obama and Biden aren't making principled arguments the other way doesn't mean such arguments don't exist, of course. The best argument I've heard against undoing this tax preference has to do with the inequities between similarly situated workers that would result. Two workers for competing firms in the same industry can have very different health care premiums, depending entirely on how old and frail their co-workers are. The quality of care they personally receive can be identical-- they can even go to the same doctor--but one's employer-paid health premiums will be higher because his co-workers are more likely to be sick.

Under this scenario, taxing employer-provided health benefits could result in the same sort of tax inequity we see in the current system. To which the most obvious response is that these inequities would certainly be less widespread than the inequities of the current system. Add to this that taxing employer-paid health benefits would provide a clear incentive for employers to offer more competitively priced benefits and this argument (which, to be clear, Biden has not even made) becomes not at all compelling.

A variety of other arguments can be made that should give us pause before rushing into paring back the existing tax break: some have to do with equity, while others have to do with the potential administrative difficulty of valuing health benefits for tax purposes. Howard Gleckman summarizes some of these arguments here, in a thoughtful read.

But at the end of the day, the most compelling argument either way is an old and simple one borrowed from the 1986 Tax Reform Act: income is income. Whether it's capital gains or pensions or unemployment benefits, the presumption should be that all types of income are taxed in the same way. Failing to do so introduces economic distortions, encouraging employers to pay their workers in the form of more lightly-taxed forms of income. Those who benefit most from these distortions will yell loudest when they're taken away-- but that shouldn't blind us to the fact that it was wrong to enact them in the first place.