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Distinguishing Policy From Politics in the Cadillac Plan Tax

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Distinguishing Policy From Politics in the Cadillac Plan Tax

October 5, 2015

The Affordable Care Act’s “Cadillac plan tax” has been much in the news of late.  A motley collection of health sector companies, conservative ACA opponents, labor unions and presidential candidates is working for repeal.  On the other side 101 health policy experts recently wrote to urge Congress to retain the tax “unless it enacts an alternative tax change that would more effectively curtail (health care) cost growth.” This piece will explain the basics of the Cadillac plan tax, some of the policy and political reasons for its enactment, and why its current precarious status was both predictable and predicted.

The Cadillac plan tax is a 40 percent excise tax, starting in 2018, on the amount by which health insurance plans’ annual premiums exceed $10,200 (individual) or $27,500 (family).  After 2020 these threshold amounts are indexed to general price inflation which – because health costs tend to rise faster than that – means that over time more and more plans will be subject to the tax.  The finances of the ACA depend to a significant extent on this projection that the tax will hit increasing numbers of plans.  This would produce a growing stream of federal revenue, funding part of the law’s ambitious expansion of subsidized health coverage.

The origins of the tax lie in a longstanding health policy problem – specifically, the federal tax preference for employer-sponsored insurance (ESI).  The problems with this longstanding tax distortion are too many to be fully described here, but among them are: it depresses wages, it drives up health spending, it’s regressive, and it makes it harder for people with enduring health conditions to change jobs or enter the individual insurance market.  Health economists across the ideological spectrum have long agreed the tax distortion is bad policy.  Numerous plans have been put forward over the years to eliminate it and to replace it with either a standard deduction or tax credit available to all insurance purchasers, not only those with coverage through their employer.  

Had the 2009-10 health reform debate been conducted solely on the policy merits, eliminating or at least scaling back the ESI tax preference would have been a centerpiece of the discussion.  But unfortunately the ACA was debated shortly after defeated presidential candidate John McCain had been successfully attacked for his proposal to replace the ESI preference with a standard credit. The ACA could not become law without the support of many who had joined or countenanced these attacks.  Sponsors thus devised the Cadillac plan tax to achieve similar policy objectives but in a different way.  The result does not eliminate the underlying tax distortion (i.e., the ESI tax preference), but rather creates a second countervailing distortion (i.e., a new tax), one that starts relatively smaller but is deliberately indexed to expand its reach over time.  The intent was that the new tax would both pay for some of the ACA’s spending, while also countering some of the longstanding tax distortion’s effect of driving up general health care costs.

One reason the public discussion over the Cadillac plan tax is so muddled is because of frequent mixing of policy and political considerations.  Keeping those issues separate is essential to thinking clearly about the tax.  Toward that end, a key policy point experts should communicate clearly to lawmakers is a simple hierarchy of best to worst options:

1) Best: eliminate or scale back the damaging distortion (i.e., no tax preference for ESI)

2) Mixed bag: continue it but have a countervailing distortion (e.g., the Cadillac plan tax)

3) Worst: Continue the distortion without mitigation (ESI preference yes, Cadillac plan tax no)

Purely on policy grounds, consensus expert opinion would rank these choices as above.  But too often the public statements of experts, such as in the aforementioned letter, obscure this policy guidance.  Here this is because some have concluded that political factors require choosing a second-best policy (#2 above) over the best policy of option #1.  A weakness of such reasoning is that based on politics alone, #2 is not as attractive as #3, which is the worst policy.  So we now have a new tax that is not optimal policy, and which faces rising political opposition as well.

I do not pretend to know the size of the gaps in political attractiveness between #1 and #2, or between #2 and #3.  My general philosophy, however, is that policy analysts like myself should remain focused on the relative policy merits, leaving it to elected officials and their staffs to work out political practicalities.  There are simply too many ways to go wrong when academics incorporate political counsel into policy pronouncements.  Doing so risks going beyond both our expertise and appropriate role. 

The Cadillac plan tax is a prototypical example of the complexities of political calculation.  It was devised to be more attractive politically than transparently attacking the ESI tax preference.  But now it faces strong opposition both from labor unions on the left and anti-tax conservatives on the right, in addition to industry interests.  From the outset it was unclear whether the tax was an example of political shrewdness or of being too clever by half.  For, as I wrote in my 2012 paper on the ACA’s fiscal effects:

“Of all of the provisions of the ACA, the Cadillac-plan tax in its current-law form perhaps warrants the greatest skepticism. It is expressly designed to expose an increasing share of health insurance benefits to taxation over time. Moreover, it did not survive its initial clash with political pressures; the form of the tax enacted with the ACA was almost simultaneously amended in accompanying reconciliation legislation, changes that both postponed the effective date and increased the thresholds below which the tax would not apply. . . To assume that the tax will always be applied to the letter of current law is to assume that political actors in the future will be far more committed to this tax than even the original authors of ACA were.”

At the time, I wrote this not to criticize the policy intent of the Cadillac plan tax but to note that it was imprudent to commit to all the ACA’s new spending before it was known whether this politically untested tax would produce all of its projected revenue.

In conclusion, let’s consider two possible answers to a legislator’s hypothetical question, “Should we repeal the Cadillac plan tax?”

1) No, unless you pass an alternative tax change that helps mitigate health care cost growth.

2) Yes, you should replace it with a law eliminating the current tax preference for employee compensation in the form of health benefits.

The two answers are substantively very similar.  But answer #2 is the superior answer (and in my view what experts should say) because it conveys the most information to lawmakers about optimal policy.  #1 can only be justified as the better answer if one incorporates judgments of political feasibility that academics are not generally in a position to make.  

It is perhaps ironic that the Cadillac plan tax, born of some political opportunism, is now a target of same.  In any case, there are plenty of people much more qualified than I (and other policy analysts) to determine the optimal balance of policy and politics.  But if unelected nonpartisan experts don’t make the direct case for best policy, no one else will.  We should all be clear that the appropriate policy goal is to remove the current-law tax distortion that has done so much damage to our health care system.


Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, a public trustee for Social Security and Medicare, and a contributor to e21.

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