CAPRETTA: Fixing job-based health insurance

In this May 22, 2020, file photo the Dome of the U.S. Capitol Building is visible through heavy fog in Washington, D.C. (AP Photo | Andrew Harnik, File)

This is the first installment of James Capretta’s article to reform employer-based health care insurance.

Employer-sponsored insurance (ESI) is central to U.S. health care. A system that arose without substantial forethought in the postwar period quickly became the expected route to health coverage for working-age Americans and is now an entrenched and dominant characteristic of the U.S. system of private insurance. But it is not without flaws: Its failure to control costs is hurting employees, as businesses compensate for rising premiums by limiting wage and salary growth. Congress needs to enact reforms to improve ESI’s cost-effectiveness and value to workers.

Fixing job-based insurance is difficult and politically controversial in any political moment, but the coming years may offer an opportunity to build bipartisan support for sensible reforms for two reasons. First, President-elect Joe Biden supports ESI, as do most Republicans. He opposes Medicare for All because it would remove the option for workers to stay with job-based insurance plans, many of which have been painstakingly negotiated with the unions. Second, Biden and his team are looking for policy levers to accelerate wage growth for middle-income Americans. Slowing the cost growth in ESI would translate directly into higher cash-based compensation for workers.

The Congressional Budget Office (CBO) estimates that 155 million people under age 65 — or nearly 57% of the non-elderly population — will be enrolled in employer plans in 2020, even after the pandemic pushes millions of workers out of their jobs and thus also out of their insurance. In 1998, 67% of the non-elderly U.S. population was enrolled in ESI. CBO expects it to remain at around 57% through the coming decade.

ESI is not a guaranteed option for all American workers. The Affordable Care Act (ACA) requirement that employers offer health coverage doesn’t apply to many smaller firms. In 2018, among workers with incomes below the federal poverty line, only 33% had an offer of ESI. In contrast, among workers with incomes above 400% of the poverty line, 79% were eligible to enroll in a job-based plan.

Employer coverage is costly. According to the Kaiser Family Foundation’s annual survey of employer plans, in 2019 firms paid about 74% of the $21,300 average annual premium for family coverage, with workers paying the remainder of the costs. This division of the premium burden creates the false impression that employers are carrying most of the load. In reality, workers in competitive industries pay their employers’ shares too because their wages and salaries are adjusted to make room for insurance plan costs. When ESI premiums rise, there is less room for growth in cash compensation.

According to the Kaiser Family Foundation’s annual survey of employer plans, in 2019 firms paid about 74% of the $21,300 average annual premium for family coverage.

This downward pressure on wages from health benefits is not new: It has persisted for many years. From 2009 to 2018, total compensation for middle-income households grew at an average rate of 2.6%, yet wages grew by an average of less than 1% annually over the same period.

Many large firms recognize that their health offerings lack cost discipline and have tried to implement corrective measures. There have been modest successes. But no single company can, on its own, fix ESI because they compete for skilled workers against other firms. Further, federal tax law encourages companies to be generous with their health benefits by exempting employer-paid premiums from workers’ payroll and income tax obligations. Because cash wages are fully taxable, firms and workers have an incentive to emphasize generosity in health coverage when deciding how to adjust compensation levels.

Expansive employer coverage contributes to system-wide cost escalation. Hospitals and physician groups organize their operations in part to appeal to workers covered by generous job-based insurance. When that coverage lacks meaningful cost discipline, the entire system becomes more expensive.

A proposal to rein in costs

The solution is a change in federal tax law so all employers must grapple with controlling costs. The ACA attempted to do this with the “Cadillac tax”: Job-based coverage remained tax-free for workers, but companies with high-cost plans were scheduled to pay a 40% excise tax on premiums above specified thresholds. It was originally scheduled to go into effect in 2018.

The business community, along with labor unions, strongly opposed the Cadillac tax, both during the initial debate on the ACA and after the law was enacted. Congress reacted to this pressure by delaying it twice before finally repealing it altogether in 2019.

To avoid repeating the Cadillac tax saga, Congress should use incentives rather than penalties to jumpstart a new attempt at ESI reform. Here, based on an AEI white paper I recently wrote, is how such incentives could work.

A firm-level tax credit for compliant coverage

CBO estimates that the aggregate value of the tax subsidy for ESI is $288 billion in 2020, or $1,850 per person enrolled in the coverage. Congress can redirect a portion of this subsidy to firms, in the form of a new tax credit, without imposing any additional costs on workers.

An example of how it might work: As mentioned above, the average 2020 ESI premium for family coverage is expected to be about $21,300, with workers paying just over one-quarter of the premium ($5,800) and firms paying the balance ($15,500). The employer share of the premium is not counted as wages for payroll or income tax purposes. This implicit tax subsidy is worth about $4,600 annually for workers in the 22% tax bracket.

The tax treatment of ESI could be altered to give firms a credit for each employee enrolled in coverage. For instance, firms could get $500 annually for workers selecting individual coverage and $1,000 for those selecting family policies. Firms would be required to apply these credits to the premiums workers owe for ESI enrollment. Further, firms receiving the credits would be required to limit the amount of their premium payments on behalf of their workers to what they paid in the year prior to enactment of this reform less roughly three times the value of the credit, or $1,500 for individuals and $3,000 for families. Placing such dollar limits on the total amounts employers could contribute toward coverage would ensure that the aggregate federal subsidy for ESI insurance did not increase with the initiation of the federal premium credits for ESI plans.

Employers would be required to hold harmless their employees by passing through the $1,500 or $3,000 reduction in premium contributions in the form of higher cash wages. Firms in competitive industries will move in this direction even without a federal requirement because of the need to offer compensation that attracts prospective employees. However, a requirement to do so will lessen workers’ fears that the reform would worsen their financial position.

(…to be continued next week. This article was first published in The Bulwark by James C. Capretta, who is a resident fellow and holds the Milton Friedman Chair at the American Enterprise Institute in Washington, D.C.)