Cadillac Tax: An Offset to the Tax Subsidy for Employer-Sponsored Health Insurance

Abstract

This entry will discuss the Cadillac tax imposed on high-cost employer health insurance (in excess of a dollar floor), its objectives as part of the Affordable Care Act (health reform) in 2010, and its subsequent modification in 2015. The history of the Act suggests that it was an alternative to limiting the exclusion of health insurance compensation from payroll and income taxes of employees to a dollar cap. The objective of the tax, in addition to providing financing for health reform, was to discourage the provision of high-cost insurance coverage and reduce health care spending. These effects, in turn, depend on the magnitude of the tax, the scope of coverage over time (which is expected to increase) and how the tax compares to the value of the exclusion of the benefits to employees from income tax and payroll taxes. Although the tax is imposed on insurers, its burden is expected to be passed on to labor income. Taxes will rise whether firms keep the high-cost insurance (and pay tax directly) or reduce insurance coverage and substitute taxable wages. The tax, currently imposed at 40%, is imposed on a tax-exclusive basis (as a percentage of the cost before taxes) while tax rates on employee wages are imposed on a tax-inclusive basis (as a percentage of cost inclusive of wages). For some employees the tax burden is smaller if the Cadillac tax is retained, while for others it is better to reduce insurance coverage. Those instances in which retaining the Cadillac tax is better have increased with the provision making the tax deductible from income tax, adopted in 2015. Only in circumstances where coverage is reduced will potential reductions in health care spending and efficiency gains from reductions in moral hazard be realized.

The views in this study do not reflect the views of the Congressional Research Service.