“Employers have no control over the amounts (other than to limit them altogether) that individual employees find necessary to meet their medical, dental and vision needs in a given year. Rational employers will terminate Health FSA and HSA programs if they must pay a tax equal to 40% of the total value of contributions into these accounts.”
William G. (Bill) Stuart
Director of Strategy and Compliance
December 7, 2017
It’s time to focus on the Cadillac Tax again.
As a refresher, the Cadillac Tax (that’s a nickname; it’s really the high-cost plan tax) imposes a 40% excise tax on all employer-sponsored medical insurance plans with premiums above a certain threshold. The concept behind this ACA provision is that employers tend to over insure their employees by providing benefit plans that are richer than employees would purchase for themselves in the individual market.
Over insured consumers tend to purchase more services, the argument goes, because their financial responsibility is only a small fraction of the total cost of the service. When patients increase the number of units that they consume, future premiums rise. An excise tax forces most employers to buy a lower-premium product, which includes higher cost-sharing. As employees pay more for services, they consume them more prudently.
That’s the economic theory, at least. There are several practical considerations, however.
First, this levy isn’t really a Cadillac Tax. It’s more like a Hyundai tax, ensnaring employers in high-premium markets who offer rather modest plans. When a policy with a deductible of $3,000 per person and $6,000 per family has a premium high enough to exceed the Cadillac Tax threshold, the mechanism simply isn’t doing a good job of distinguishing between over insurance and high market premiums.
Second, the calculation of the premium threshold above which the tax applies includes not only the medical insurance premium, but also the value of a Health Reimbursement Arrangement (HRA) and employer and employee elections to a Health FSA or cash contributions to an HSA. This is a real sticking point. Employers can control the cost of premiums and the value of HRAs via plan design. They have no control over what individual employees elect to their Health FSAs or contribute to their HSAs.
Imagine an employer whose medical plan premium and HRA equal the threshold for individual coverage, projected to be $10,800 in 2020. The employee then elects $2,000 to her Limited-Purpose Health FSA to cover dental services and $3,000 to her HSA to reimburse eligible medical expenses. Her combined tax rate (federal and state income taxes plus federal payroll taxes) is 31%. Thus she saves $1,550 in taxes on her $5,000 salary reductions. The excise tax on these employee salary reductions is $2,000.
No employer is likely to allow employees to save $1,550 in taxes (plus save $382.50 on the employer portion of payroll taxes) if it costs the employer $2,000 to offer this benefit. And surveys bear this out. A poll conducted last year shows that 19% of employers offering Health FSAs and 12% offering HSAs are reviewing their commitment to these plans with the Cadillac Tax looming.
The Road Not Traveled
This past spring and summer, we in the industry had hoped that the ACA amendment efforts would change the pending imposition of the excise tax on high-cost medical insurance, either by eliminating or delaying this tax. Those dreams died when Senate Republicans couldn’t muster 50 votes to pass a bill.
We then hoped that this fall’s tax-reform effort would provide our clients and customers with some relief, since the Cadillac Tax is, after all, a tax, and thus germane to a tax bill. Alas, those dreams were squashed when Sen. Dean Heller (R-NV) announced that he wanted to keep the tax bill focused on taxes and to handle all health-insurance issues in separate legislation. This approach drew guffaws in the industry, since Heller advocated including the repeal of the individual mandate to purchase insurance in the tax bill.
The justification for this seeming inconsistency is that repealing the mandate and associated penalty actually counts as a revenue raiser in the “scoring” of the tax legislation. By contrast, according to the Congressional Budget Office, which determines the revenue impact of proposed legislation, the Cadillac Tax is a huge revenue generator. Its model assumes that all Health FSA participants and HSA owners contribute to the maximum in their accounts each year, thus mistakenly (by a factor of more than twice reality) magnifying the revenue loss to the federal government.
While the tax bills passed by the House and Senate differ in content, neither addresses the Cadillac Tax directly. Indirectly, though, the Senate bill impacts the tax. The threshold is adjusted annually by the general Consumer Price Index (plus an additional 1% in 2019 and 2020). That figure is well below the rate of medical inflation, so each year more plans are subject to the penalty. The new bills change the adjustment mechanism to chained CPI.
Chained CPI includes a substitution effect (if all you eat is steak and its price doubles, your cost of protein doesn’t double because you substitute hamburger, chicken and kidney beans for some of the steak that you previously consumed). This slower-rising index ensures that the threshold will increase even more slowly than medical inflation, thus accelerating the rate at which plans are subject to the 40% levy.
The Path from Here
In late November, some colleagues from the Employers Council on Flexible Compensation and I visited health and tax aides for a number of members of Congress in both chambers and on both sides of the aisle. Our message was simple:
- Repeal the tax. It ensnares too many employers and employees who have plans with high-cost sharing and high premiums due to medical costs in their geographical market or are part of an older work force. Plus, it discourages employers from offering Health FSAs and HRAs, which results in a tax increase on workers with family incomes that average less than $60,000. The ACA offers advance premium tax credits to families making up to 400% of the federal poverty level (more than $1,000 for a family of four) to help offset the rising cost of premiums in the individual market. It doesn’t seem fair for lawmakers to effectively withdraw a tax advantaged program that allows families that, on average, earn less than 300% of the FPL.
- Delay the tax. We understand the difficulty that members of Congress face when trying to find an offsetting revenue source to compensate for the revenue loss (however inflated) from repealing the tax. As an alternative, we propose a long delay in implementing the tax. Large employers are already working on 2019 plan designs, and many unions (a key area of concern for Sens. Claire McCaskill of Missouri and Debbie Stabenow of Michigan) are negotiating multi-year contracts. We proposed that the Cadillac Tax delay be included in the rumored legislation to delay implementation of the Health Insurance Tax (HIT) and the medical device tax, two other unpopular ACA levies.
- Eliminate employee salary reduction from the equation. We understand (sort of) if the government wants to use the tax to discourage employers from offering rich coverage. And employers choose their medical plan and HRA designs. Employers have no control over employees’ salary reductions into a Health FSA or HSA short of placing severe limits on their contribution levels. Those limits act as a tax increase for families with high expenses.
There is an additional fall-back position advocated by employers who cover employees in regions with high medical costs. Their approach is to apply the tax based on the actuarial value of the medical plan. In other words, to use the lexicon of the ACA marketplaces, the tax might apply to Platinum and Gold plans, which pay on average about 90% and 80% of total claims costs, respectively, but not to Silver (70%) and Bronze (60%) plans. This approach would not penalize employers and employees in high-cost regions or companies with older employees.
US Reps. Joe Courtney, a Democrat from Connecticut, and Mike Kelly, a Republican from Pennsylvania, introduced legislation last week to repeal the Cadillac Tax. They submitted a letter to each party’s leader, signed by 142 colleagues asking that the tax be repealed. You can read the text of the bill here.
I met with both Reps’ staffs in March. Courtney has long been an opponent of the Cadillac Tax who was thwarted by his party leadership from working across the aisle to address this issue during the spring, when House Republicans ultimately passed a bill amending portions of the ACA (an exercise that died in the Senate months later). Kelly, a businessman with decades of experience running auto dealerships, understands better than most members the impact of higher benefits costs on small businesses.
What You Can Do
How can you become a voice in this policy discussion?
First, become educated on the issue. Here are two organizations, one organized by trade groups and the second by large employers and policy advocates, that provide a wealth of information on this topic:
My Money, My Health. This organization is focused on removing employees’ Health FSA elections and employee and employer HSA contributions from the Cadillac Tax calculation. When these contributions are included, employers are less likely to offer either program, which results in a tax increase for middle-class families. My Money, My Health is particularly focused on employee salary deferrals because employers have no control over the amounts (other than to limit them altogether) that individual employees find necessary to meet their medical, dental and vision needs in a given year. Rational employers will terminate Health FSA and HSA programs if they must pay a tax equal to 40% of the total value of contributions into these accounts.
Alliance to Fight the 40. The Alliance advocates eliminating the tax entirely so that neither medical plans nor accounts are subject to the penalties. The Alliance’s central argument is that group medical insurance, which covers 178 million Americans, ensures families’ protection against medical loss. It argues that having employer groups at the center of the purchasing decision increases benefit innovation, creates larger risk pools that help manage premium costs and incents employers to create programs (like general wellness and workplace safety) that reduce claims costs. The Cadillac Tax, the Alliance argues, threatens the very structure that insures most working Americans.
Second, write to your three representatives in Congress. In my visits to both Democrats and Republicans in both the House and Senate, I’ve found no elected official who supports the Cadillac Tax. They generally fall into two categories: Those who want to eliminate the levy altogether and those who favor repeal but want to see a revenue source to offset the loss of projected revenue if the tax is axed. It’s always helpful when you include personal narratives of how these accounts have help you or a family member manage costs associated with a sick child or a spouse with a chronic condition.
“A Date Which Will Live in Infamy”
Today is Dec. 7, which is my parents’ generation’s equivalent of my generation’s Nov. 22, 1963 and my kids’ generation’s Sept. 11, 2001. The bombing of Pearl Harbor has special meaning to my family. My grandmother took a steamship to Honolulu in late November 1941 for a vacation with my grandfather, a US Naval Academy graduate who had been stationed in Guam since March 1940. While they were in Honolulu, my grandfather received his orders to transfer to Washington, DC. My grandparents left Honolulu late Dec. 5 on the SS Lurline, headed for San Francisco. They were in the middle of the Pacific when Japanese pilots bombed and sank most of the US Pacific Fleet moored in Pearl Harbor.
The male passengers on the Lurline, including my grandfather and a young football player named Jack Robinson, who had finished a season playing professional football, were among the men who painted everything on the Lurline above the water line gray to reduce its visibility to potential enemy bombers. The ship arrived in San Francisco safely, despite the peril. Another ship carrying Christmas trees from Oregon to Hawaii was torpedoed and sank in the vicinity of the Lurline.
My grandfather returned to the South Pacific and spent much of the remainder of the war there as a member of the Civil Engineering Corps. Robinson didn’t play much more professional football (though he had been a star running back at UCLA), but instead turned to professional baseball, where he became a trailblazer and Hall of Famer.
What We’re Reading
Did Maine voters make a mistake in voting to expand Medicaid in the Pine Tree State? Sally Pipes, president of the Pacific Research Institute, thinks so. Learn why here.
The House and Senate passed different tax reform bills. The two chambers must now go to conference committee and draft a single bill on which both will vote. The two bills passed have some key differences. The Kaiser Family Foundation outlines some key provisions that impact health care.