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What Should Conservatives Do on the ESI Exclusion?

1AW Paragon Prognosis ESI Exclusion0
Brian Blase
President at Paragon Health Institute

Brian Blase, Ph.D., is the President of Paragon Health Institute. Brian was Special Assistant to the President for Economic Policy at the White House’s National Economic Council (NEC) from 2017-2019, where he coordinated the development and execution of numerous health policies and advised the President, NEC director, and senior officials. After leaving the White House, Brian founded Blase Policy Strategies and serves as its CEO.

What Should Conservatives Do on the ESI Exclusion?

Over the past decade, some of my best friends in the liberty movement have groaned when I told them I favor capping the exclusion for employer-sponsored health insurance (ESI) because they believe it’s a bulwark against a single-payer system and politically futile. But I believe both tax policy and health policy would be improved by capping the ESI exclusion. That said, the clear top health tax priority for conservatives must be allowing the enhanced Affordable Care Act (ACA) premium tax credits (PTC) to expire.

In Follow the Money: How Tax Policy Shapes Health Care, Theo Merkel and I tackle the exclusion, the PTC, and other key health tax provisions like health savings accounts and individual coverage health reimbursement arrangements. In this Prognosis, I describe the exclusion, my changed view on how conservatives should approach it, and why the enhanced PTC is the most serious problem in this area.

What is the ESI Exclusion and What Are Its Effects?

Health insurance premiums for employer coverage are excluded from federal income and payroll taxes. Economists generally agree that the exclusion causes employers to offer more expansive health insurance than they otherwise would offer, thus increasing health care spending. Since employers can compensate workers with wages or benefits, more compensation in the form of benefits means less compensation in the form of wages. Economists agree that the exclusion depresses wages. Since the U.S. has a very progressive income tax, the exclusion is regressive, meaning that higher-income households receive a disproportionate benefit.

Those who oppose capping the exclusion argue that ESI is the bulwark against single-payer health care and that policymakers should support ESI. Some also argue that ESI is a very efficient form of health coverage. And still others argue that it’s not really a health care subsidy; it just lowers taxes. The argument that I have become most sympathetic to over the past few years is that the exclusion is a relatively cheap way for the government to maximize health coverage since the Affordable Care Act (ACA)’s exchange subsidies are about three times more expensive on a per-enrollee basis.

The Lessons from the Cadillac Tax

One of the only provisions of the ACA which I supported was its Cadillac tax, which was an awkward form of an ESI cap. Given the opposition of both business and labor groups to the Cadillac tax, it was not scheduled to take effect until 2018—nearly eight years after the ACA was signed by President Obama. While Team Obama thought the tax was essential to lower costs, there was never a strong coalition to maintain it.

If it had been permitted to take effect, the Cadillac tax would have imposed a 40 percent excise tax on health insurance policies valued in 2018 at more than $10,200 for single coverage and above $27,500 for family coverage.

In big bipartisan majorities, Congress delayed and weakened the tax in 2015, delayed it again in 2018, and then repealed it outright in 2019. In 2015, I wrote a Forbes piece criticizing what Congress did, lamenting how conservatives gave up any leverage they had to address problems with the exclusion. In 2019, I wrote in The Wall Street Journal that Congress should not repeal the Cadillac tax but should instead exempt contributions to health savings accounts from counting toward the tax threshold.

Notwithstanding my compelling arguments, more than 90 percent of members of Congress voted to repeal the Cadillac tax and President Trump, for whom I worked, signed the repeal into law. The lesson I took is that conservatives should not spend capital trying to cap the exclusion.

Health Tax Problem #1: Enhanced ACA Premium Tax Credits

In this article about the exclusion, why must I bring up the ACA PTCs? It’s because the number one target for conservatives in the health tax space must be reforming the PTC—subsidies which now go directly from the Treasury to health insurers. Most importantly, Congress should allow the enhanced PTCs to expire after 2025.

In 2021, Congress increased the size of the PTCs and made people in the top two income quintiles eligible for them. The enhanced subsidies mean that nearly half of all enrollees are now enrolled in fully-subsidized taxpayer plans. A lack of appropriate income verification and lax penalties for people who misstate income to claim a larger subsidy means that many people are receiving subsidy amounts for which they are not legally entitled. Moreover, many people enrolled in coverage are unaware they are enrolled. The authors of the ACA did not intend for there to be fully-subsidized plans for any enrollees, much less half of enrollees in such plans. This harms plan quality as insurers no longer need to focus on providing enrollees with value in their plans as people will enroll even if the benefit they receive is virtually zero.

The Congressional Budget Office recently estimated the cost of continuing the enhanced subsidies at $400 billion over a decade, a substantial cost given the massive U.S. budget deficit and rising federal interest payments. The subsidies are inflationary, giving insurers significant pricing power since enrollees are insulated from the rising cost of the premium with the taxpayer on the hook to subsidize ever-higher premiums.

The enhanced subsidies also provide small businesses with large incentives to stop offering workplace coverage, which in turn leads to higher taxpayer costs as employees gravitate to ACA plans. Employers can increase worker wages when workers go to the exchanges for their coverage and receive a large subsidy—with federal taxpayers now footing the costs.

In our paper, Theo and I make a series of recommendations on how to reform the PTC, including by capping the benchmark premiums at 125 percent of the national average and permitting enrollees an option to take a portion of the subsidy as a payment to a tax-advantage health account under their control.

Conservatives must unite on ending the enhanced subsidies and put aside our divisions on the exclusion for now. The enhanced subsidies are a much more immediate threat — and have a more actionable solution.

Only Tackle the Exclusion if Doing Broad-Based Health or Tax Reform

Ideal tax reform involves broadening the base, lowering marginal rates, and reducing tax carveouts. This was accomplished in two of the most successful tax reforms in American history—the 1986 Reagan reforms and the 2017 Trump reforms. Both of those reforms also produced strong economic growth and tax receipts that exceeded projections.

In our paper, Theo and I decided that it would be disingenuous to do a health tax reform paper without making recommendations to the exclusion. We think that tax and health policy would be significantly improved by capping the exclusion, which we propose to do at 125 percent of the average value of an employer plan – adjusted for the age of an employers’ workforce. This policy would reduce excessive health care spending, increase workers’ wages, reallocate resources away from health care to more productive sectors of the economy, and lead to higher overall economic growth. But crucially, reforming the exclusion only makes sense if the enhanced ACA PTCs first expire.

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