Study Suggests How Employer-Provided Health Benefits are Taxed Could Impact Provision of Coverage

report3.JPGAccording to an Issue Brief (pdf) drafted by the Employee Benefit Research Institute (EBRI), efforts to reduce the national debt that include proposed changes to how employer-provided health coverage is taxed could have a significant impact on employee health coverage purchase decisions, especially in light of new options offered by the Affordable Care Act. According to the EBRI report, favorable tax treatment of employment-based health coverage “is the largest tax expenditure in the budget, making it an almost inescapable target as the United States addresses severe financial issues related to the deficit and the debt.” Efforts to change or eliminate the favorable tax treatment of these plans could make employer-provided coverage less attractive to employees, and ultimately lead to fewer employers offering it.

Among other ways of reducing the national debt, the Administration’s National Commission on Fiscal Responsibility and Reform has proposed reducing – and then eliminating – the preferential tax treatment of employment-provided health insurance benefits for employees. Specifically, the proposal would first cap the tax exclusion for worker income at the 75th percentile of premiums paid in 2014, then freeze the cap at this level through 2018. After this point, the exclusion would be gradually phased down, then eliminated entirely by the year 2038. The current proposal would not change the treatment of employer-provided insurance as a deductible business expense. The EBRI report points out, however, that other budget proposals, including those offered by President Obama and House budget Committee Chairman Rep. Paul Ryan (R-WI), would not change the current tax treatment of employer-provided coverage.

As discussed in the EBRI study, eliminating the tax preference combined with the market reforms imposed by the Affordable Care Act “could have major implications for the future of the employment-based health benefits system.” While the Affordable Care Act includes incentives for employers to continue offering health coverage, the law necessarily “changes the playing field in that workers will no longer need to rely on their employer to obtain health coverage.” Therefore, any changes to how employment-based coverage is taxed could dramatically impact the number of employees who opt for such coverage instead of obtaining health benefits through future health insurance exchanges.

The study acknowledges that how employees react to any increased tax burden would dictate an employer’s response. For example, the study states that on average, workers will pay approximately $1,500 in out-of-pocket expenses for employee-only coverage in 2014. According to the EBRI, some will consider the net premium offered by the future health insurance exchanges to be lower than their share under an employer-provided plan. Employees in lower tax brackets will find the exchange to be more advantageous than higher-earning employees.

If a cap on the exclusion from worker income is imposed in lieu of completely eliminating the preferential tax treatment, worker preferences for the health exchange will be reduced according to the EBRI. The 40% “Cadillac” excise tax on high-cost health plans is a form of tax cap. The higher the cap is set, the study finds, the less likely workers will prefer the exchange over employer-provided coverage. In this instance, an employer might attempt to reduce an employee’s tax burden by cutting health benefits to reduce premiums to fall below the tax cap threshold. Any move to less comprehensive coverage, however, could make employer-provided coverage less attractive.

The report concludes by noting that if workers switch to exchange-provided coverage because of the less preferential tax treatment of employer-based coverage, or similar tax cap or reform measures that makes employer-provided health insurance less attractive, employers may stop offering such benefits altogether. The number of those preferring coverage through an insurance exchange will necessarily depend on, among other things, the relative premium offered in each option and the employee’s income level. The EBRI notes that the study’s findings do not take into account changes in out-of-pocket expenses or other employee preferences.

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Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.