How Will the Cadillac Tax Impact Healthcare Markets?

Starting in 2020, a 40% tax will be levied on employer plans in excess of $29,000 for family coverage and $10,700 for individual coverage.

The Cadillac tax that will go into effect in 2018 is a crucial tool in helping improve the healthcare system, which has shown progress in the last few years, according to a commentary published in The New England Journal of Medicine.

The United States tax code has undermined incentives for private sectors to improve the healthcare system. Employees are responsible for paying income and payroll taxes on wages but not on compensation in healthcare benefits.

Many employers skew compensation packages away from wages and towards health benefits that are both inefficient and excessive in cost, according to authors Jason Furman, PhD, and Matthew Fiedler, PhD.

In order to address this, the Affordable Care Act created a tax on high-cost employer sponsored coverage, where a 40% tax will be levied on employer plan costs in excess of approximately $29,000 for family coverage and $10,700 for individual coverage. The date for the excise tax to go into effect was delayed from 2018 to 2020 by the US Congress.

Tax thresholds were set way above the cost of plans held by most workers intentionally so they could target the least efficient plans, the study found.

Employers that have higher costs because of factors like age, sex, and the industries they operate in, will qualify for even higher thresholds to help ensure that the tax targets overly generous plans instead of firms with workers with higher than average healthcare needs.

The Department of the Treasury Office of Tax Analysis (OTA) estimates that 7% of the people who are enrolled in employer-sponsored coverage will have plans that will be taxed when the 2020 Cadillac tax takes effect.

These numbers overstate the actual impact of the tax because it only applies to a portion of the plan costs that exceed the thresholds, the study noted. The OTA estimates that only 1% of plan costs will be affected in 2020 and only 4% by 2026.

The tax’s targeting will be further improved by the president’s fiscal year 2017 budget proposal, according to the authors. States that have an average premium for gold coverage plans on the states individual health insurance marketplace, would exceed the exercise tax threshold. Under the current law, the threshold will instead be set at the level of average gold premium.

“This policy prevents the tax from creating unintended burdens for firms located in areas where health care is particularly expensive, while ensuring that the policy remains targeted at overly generous plans over the long term if health costs rise faster than the tax thresholds (which will rise with the overall Consumer Price Index),” the authors wrote.

Additionally, the tax should drive employers to make health plans that are more efficient. The Congressional Research Service estimates that the tax will decrease national health expenditures by more than $40 billion in 2024, followed by more savings in the years following.

Currently, Medicare payment reforms reduce costs in the private sector and private payment reform efforts generate benefits for other payers. Similarly, the Cadillac tax that directly affects cost-cutting effort plans could have substantial spillover benefits for the rest of the market.

It’s suggested that employers will save on health benefits, which will eventually benefit workers with higher wages. The Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) believe that the tax could lead to an increase in pay for Americans at approximately $50 billion annually by 2026.

These increased wages will help reduce deficits, by booting income and payroll tax collections, the authors predicted. CBO and JCT estimates suggest the Cadillac tax will reduce deficits by $95 billion over 10 years, ending in 2026. Furthermore it could reduce the deficit by more than $500 billion over 10 years and thereafter.

“In addition, healthcare markets — including pharmaceutical, physician, hospital, and insurance markets — feature sellers with substantial market power,” the authors wrote. “By increasing employers’ incentives to negotiate for better prices and steer enrollees toward lower-priced providers, the tax will help check that market power and drive prices down.”