Who Should Pay for Health Care Reform – the Rich or the Richly Insured?

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Senators Sherrod Brown, Bernie Sanders and Al Franken just introduced an amendment to the Senate health reform legislation that will make the unions happy. They proposed eliminating the bill’s tax on so-called “Cadillac health plans” and replacing it with a new tax on immensely rich Americans. The new tax would be 5.4% and would apply to individuals earning more than $2.4 million per year. The Senate bill as it’s currently written would instead apply a 40% tax on health insurance plans that cost more than $8,500 for families and $23,000 for families. (Only the excess amount would be taxed.) The changed called for by the three senators would bring the Senate bill more in line with the House reform bill, which would impose a 5.4% tax on individual income over $500,000.

I know – lots of numbers and detail and wonk. Here’s the central point of debate in all this. Is it better to pay for health care reform on the backs of rich Americans or on the backs of Americans with generous health insurance plans?

There are other savings and revenue-generating provisions in Democratic health reform bills to offset spending, but taxing high-cost insurance is a major one. Republicans and some Democrats have been criticizing the Cadillac tax as one that will unfairly tax middle class Americans. (Remember the Obama campaign promise that he wouldn’t raise taxes on individuals making $250,000 or less? Republicans certainly do.) As Brown, Franken and Sanders well know, municipal and manufacturing union members – i.e. members of the middle class – make up a huge portion of those who could get snagged in the Cadillac tax net. (Many unions have, in recent years, negotiated for more expensive health plans instead of higher wages.) The Congressional Budget Office has estimated that 19% of employer-sponsored health plans could be subject to this tax three years after it goes into effect. Taxing rich Americans is an easier sell and would affect few pocketbooks. But to frame the debate just in these terms misses the other intended effect of the Cadillac tax, which is to lower health care spending.

Many health care economists studying the legislation currently on the table cite the Cadillac tax as one of the few provisions most likely to bend the cost curve. They say that having the Cadillac tax looming will lead employers to cut back on price of the insurance plans they offer to employees. Employers who do this quickly enough – the Cadillac tax wouldn’t kick in until 2013 – would never see their health plans hit the $8,500 and $23,000 limit. (According to the Kaiser Family Foundation, the average premium for employer-sponsored coverage for individuals and families in 2009 was were $4,824 and $13,375 respectively.)

Those with Cadillac health plans generally don’t have any incentive to look for efficient and cost-effective care. They shell out only tiny co-pays for doctor visits, can often see any provider they like and can receive unlimited benefits. Sounds great, right? Well yes – on a personal basis – it is. But economists know that when people don’t have any “skin in the game,” i.e. incentive to make financially prudent health care decisions, spending gets out of control. While it may sound cold to say that people should make some health care decisions based on cost, this is one of the real purposes behind health reform that proponents don’t spend a lot of time talking about. (Here’s an article I wrote over the summer when the idea of the Cadillac tax was first proposed.)

According to a Senate aide, the original Brown-Sanders-Franken amendment would have mirrored the House provision to only tax Americans earning more than $500,000 per year, but was tweaked to exactly replace the amount generated by the Cadillac tax – $129 billion over 10 years. So the hole created by eliminating the Cadillac tax would be filled, but how a new tax on rich people will help motivate a society to spend less on health care is still not clear.