Eliminating tax benefits for employer-provided health coverage may drive workers to insurance exchanges

Although several recent studies suggest that federal health reform legislation will help to reverse a long-term reduction in employer-provided health insurance coverage, despite a McKinsey and Company report to the contrary, an added complication could be the elimination or reduction of federal tax breaks for employer-provided coverage, as part of debt reduction efforts. According to an analysis from the nonpartisan Employee Benefit Research Institute (EBRI), workers may prefer to enter health insurance exchanges rather than keeping employment-based health coverage if the tax treatment for employer-provided health benefits is eliminated or significantly cut back as part of the federal debt reduction effort.

According to the EBRI analysis, most workers would face an increase in taxes and might then question the value of keeping employer-provided health coverage if they have to start paying taxes on a benefit that is currently not taxed. Lowest-income workers in particular, would find the health exchanges more advantageous than employment-based health benefits, while higher-income workers would not, EBRI suggests.

Further, if enough workers do not prefer their employer's health benefits, EBRI predicts, the likelihood would grow that many employers would stop offering health benefits at all. "Even if only a fraction workers preferred an insurance exchange over employment-based coverage, it would send a clear message to employers that millions of workers will no longer value the benefit," said Paul Fronstin, director of EBRI's Health Research and Education Program and author of the report. However, EBRI acknowledges that “predicting how this might play out by firm size, industry, worker earnings, geographic region, among other things, is highly uncertain.” The findings are published in the July 2011 EBRI Issue Brief, "Employment-Based Health Benefits and Taxation: Implications of Efforts to Reduce the Deficit and National Debt."

Debt reduction efforts. As EBRI points out, the tax preference associated with employer-provided health coverage is the largest tax expenditure the U.S. budget, accounting for $1.1 trillion in foregone tax revenue during 2012-2016. By contrast, retirement plans account for about $700 billion in foregone tax revenue and the mortgage interest deduction accounts for about $600 billion, EBRI says, suggesting that this makes the tax treatment of health coverage “an almost inescapable target.”

President Obama's bipartisan National Commission on Fiscal Responsibility and Reform released proposed changes in December 2010 that would achieve $4 trillion in deficit reduction by 2020. As part of the proposal, the commission called for reducing the preferential tax treatment of employer-provided health benefits as they apply to workers. Under the proposal, the tax benefits would be reduced, first by capping, then freezing, phasing down, and ultimately eliminating them. The Commission did not recommend any changes to the employer deduction as a business expense.

Coverage. Under current law, workers will be able to enroll in health insurance exchanges beginning in 2014 as a result of last year’s federal Patient Protection and Affordable Care Act (PPACA).

According to EBRI, employment-based health coverage is the most common source of health coverage in the United States. In 2009, 59 percent of nonelderly individuals were covered by an employment-based health benefits plan, with 68.2 percent of workers covered, 34.6 percent of nonworking adults covered and 55.8 percent of children covered.

    For more information. For a comprehensive analysis of the Patient Protection and Affordable Care Act, including the full text of the law and additional information on health reform implementation and other recent developments in employee benefits, just click here.