To Excise Tax or Not to Excise Tax

By Dave

Public policy is hard. There are very few opportunities left to make Pareto Improvements.  I don’t believe in utopia. Everything involves a trade-off. To me, it's no surprise that all public policy creates winners and losers. The job of those crafting policy and those who are watching it be crafted is to evaluate the policy based on a range of criteria and then ask if it does more good than bad. If so, then it can be called, "good policy" and should probably be implemented.

That's how I approach Bob Herbert's piece in the NYT. I think the excise tax and other cost-controls will make the country better off as a whole, but some people will be made worse off than they are today. Herbert, on the other hand, calls the excise tax a “Less than Honest Policy”. Here are a few snippets:

Proponents say the tax will raise nearly $150 billion over 10 years, but there’s a catch. It’s not expected to raise this money directly. The dirty little secret behind this onerous tax is that no one expects very many people to pay it. The idea is that rather than fork over 40 percent in taxes on the amount by which policies exceed the threshold, employers (and individuals who purchase health insurance on their own) will have little choice but to ratchet down the quality of their health plans.
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Proponents say this is a terrific way to hold down health care costs. If policyholders have to pay more out of their own pockets, they will be more careful — that is to say, more reluctant — to access health services. On the other hand, people with very serious illnesses will be saddled with much higher out-of-pocket costs. And a reluctance to seek treatment for something that might seem relatively minor at first could well have terrible (and terribly expensive) consequences in the long run.
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Those who believe this is a good idea should at least have the courage to be straight about it with the American people.

So I'm sympathetic, but I think he's wrong in his analysis. Here’s what I know about the excise tax and here’s why I support it.

From the CBO report:

Beginning in 2013, insurance policies with relatively high total premiums would be subject to a 40 percent excise tax on the amount by which the premiums exceeded a specified threshold. That threshold would be set initially at $8,500 for single policies and $23,000 for family policies (with certain exceptions); after 2013, those amounts would be indexed to overall inflation plus 1 percentage point.

Herbert's right that the excise tax is a revenue generator and over the long term will help reduce the deficit. But it's also a cost control designed to reduce the costs of health insurance.

In fact, Christina Romer, the Chair of the Council of Economic Advisors, called it "probably the number one item that health economists across the ideological spectrum believe is likely to stem the explosion of health-care costs."

and MIT Economist Jonathan Gruber says:

It would reduce the incentives for employers to provide excessively generous insurance, leading to more cost-conscious use of health care and, ultimately, lower spending. In other words, it "bends the curve." It would also be progressive, in that it would take from those with the most generous insurance to finance the expansion of coverage to those without insurance.

The national average cost for a family is $13,000. The excise tax has been dubbed a “Cadillac tax” because it will tax high-deductible plans, ones that cost more than $23,000 a family. The intention of the tax is no dirty secret. In fact, it should be no secret at all. It's job is to create a powerful incentive for insurers to be very wary when they increase their premiums. If their plan gets too expensive, the price will snow ball and get very expensive, too expensive for most people. This will drive consumers into the lower priced plans of their competitors, which should be more available through the new insurance exchanges.

In Herbert’s mind, this is the same as ratcheting down the quality of a plan. But if there is anything we’ve learned in the last few months it’s that price and quality are not always correlated in health care. In fact, we spend huge amounts of money and get lower outcomes. Just look at this graph from National Geographic if you needed any more evidence.


Here's Ezra Klein:

First, more insurance is not always better. Health-care outcomes in Canada and England -- both of which have strong pressures against overuse -- are not worse than those in America. More to the point, health outcomes in Kaiser Permanente, which is a managed-care organization, are not worse than those in Aetna's more expensive PPO plans.

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But loose rules also encourage a lot of waste -- estimates run at about 15 to 30 cents of every dollar we spend. That waste won't be painless to cut out of the system, but it'll be less painful -- and less harmful -- than anything else.

So we have to get rid of the waste and the excess. No doubt the excise tax is a crude implement to accomplish this and there are ways that we could improve it, such as allowing the threshold to change based on demographics. But by penalizing insurers who charge too much we can stop the excessive creep of health care costs.

The other part of health care reform means getting away from an employer-based model of health care. In the long-run this will be better for both workers and employers. But in the short run, there will be people who will lose. As Herbert notes, the Unions are not thrilled about this. In fact, they are openly opposing it. But of course they are! Unions currently receive a $250 Billion a year subsidy from the US taxpayer on health insurance plans. So of course they oppose it. Who wouldn’t grumble if a chunk was taken out of their giant subsidy?

But this subsidy is a problem. It encourages waste because employers can offer bigger packages during labor negotiations and they’re worth more because unlike wages they’re tax-free. So companies keep dumping more money into exorbitant health insurance packages and workers think they’re better off, but for the money being dumped in, it’s more likely their getting a raw deal.

However, the excise tax probably makes workers better off in the long run. Gruber again:

Moreover, most experts and Congress's Joint Committee on Taxation assume that most companies would not end up paying this tax but would instead reduce their insurance spending to below the threshold for the tax. And when firms reduce their insurance generosity, they make it up in higher pay for their workers. We saw this in the late 1990s, when the rise of managed care temporarily lowered insurance costs, and wages rose in real terms for the first time in many years. But as soon as managed care was weakened and health costs rose again, we once again saw flat or declining real wages in the United States.

By my calculations the excise tax in the Senate legislation will raise U.S. worker wages by a total of $223 billion over the next decade, which would mean about $660 in extra annual earnings per employer-insured household by 2019. Moreover, the vast majority of those wage increases accrue to middle- and lower-income households; 90 percent would go to families with incomes below $200,000.

So the excise tax will reduce the national deficit, bend the cost curve in health care, encourage insurers to provide more affordable plans, wean the country off employer-based health care, and maybe lead to better wages over the long-run for workers. I'd say this is good policy, not great policy. But on the whole, if we hope to control costs, these are the types of things we have to do.