Deleting a Tax Subsidy from the Equation

John McCain lost the election, but the centerpiece of his health plan -- taxing the amount employers pay for their employees' health insurance -- may win. The idea is gaining momentum, and President Barack Obama shows a willingness to consider an approach that he ripped during the campaign.

This can be viewed simply in political horse-race terms, as Obama flip-flopping on a campaign issue. However, it also reveals a coalition of groups that agree a consequential reform is needed, even if they don't agree on the problem(s) of the system.

This tax subsidy began during World War II because large employers wanted a way to compete for employees without violating wartime wage controls. The policy has resulted in several generations of workers viewing insurance as a benefit that was paid for largely by others, undoubtedly increasing health spending, for good and bad.

My family receives insurance through my job, with Duke University paying about $550 a month in premiums. (I pay $335 a month.) I do not pay income or payroll taxes on what Duke pays, giving me $6,600 of tax-free income last year. This provision of the tax code (called a tax expenditure) cost the U.S. Treasury about $250 billion last year.

The reasoning of this odd coalition goes as follows.

Libertarians and some conservatives would like to end this tax expenditure because it shields consumers from the cost of their health insurance, leading to more generous insurance than would be purchased with after-tax dollars. Distortion of market forces driven by too much insurance and overuse of care is seen by this group as the biggest system problem. Ending the tax expenditure would cause employees to ask employers for smaller policies, and some employers would stop providing insurance, meaning more individuals would arrange their own insurance, making them better consumers of health care.

Deleting a Tax Subsidy from the EquationThe president, Democrats in Congress and reform advocates are desperate to pass a law that will increase insurance coverage. This group sees the main system problem as the uninsured, and the costs and inefficiencies inherent in how the uninsured now get care.

There's an effort to cobble together a coherent plan that will increase coverage through employer mandates, individual mandates, Medicaid expansions, a new public option or some combination of these. But it appears that any plan costing more than $1 trillion over 10 years seems unpalatable ($100 billion is about 5 percent of total annual system expenditures). Ending or limiting the tax preference of employer-provided insurance is among the most dependable means of paying for reform, which is key since the president has pledged to do so on budget-neutral terms.

Many liberals prefer a single-payer approach, essentially Medicare for everyone, on both efficiency and justice grounds. This seems politically impossible. However, if single-payer is dead, some proponents are willing to end the employer-provided insurance subsidy on fairness grounds: Benefits flow mostly to high-income persons. I have a good job and get $6,600 in tax-free income; someone working a low-wage job that doesn't provide health insurance, the self-employed and the uninsured get $0.

Further, ending this subsidy would reduce the employer's role in purchasing insurance. If consumers have difficulties navigating the individual-based market as many suspect they will, the aggravation could later make a single-payer approach more palatable.

Repealing or limiting the unlimited tax subsidy of employer-provided health insurance would represent a fundamental change in the system. What are the likely results?

The role of employers in purchasing insurance would likely decline, and more individuals would play an increased role in obtaining their own insurance, with those who now have very generous employer-provided policies perhaps facing more of the actual costs of their care. This is a plausible way to pay for health reform that does not depend upon best-case assumptions or future efficiency gains that may not materialize.

The real questions are how effective the mix of approaches agreed to by the president and Congress will be at reducing the number of uninsured, and at what cost.

Donald H. Taylor Jr. is an assistant professor of public policy. His blog is available for discussion of this article and health care reform in general. This article was first published in The (Raleigh) News & Observer on July 10, 2009.  This is part of a weekly series of articles by Donald Taylor exploring aspects of the health care reform issue.