≡ Menu

Economists love Obamacare’s “Cadillac” tax, but is it really a good idea?


Even among supporters of the Affordable Care Act, the law’s “Cadillac tax” on expensive employer-provided health plans has never been popular. Unions hate it because in many cases it will be their members’ health plans that are hit, and all three Democratic presidential candidates have called for its repeal. Meanwhile, on the other side, big corporations don’t like it either, since it could force them to choose between cutting back on benefits or paying more for healthcare, and a number of prominent Republicans, like House speaker Paul Ryan, want to repeal it as well.

Really it seems like the only people in favor of the Cadillac tax are economists– but they really like it. One hundred and one economists signed an open letter saying that it will lower health spending and asked Congress to “take no action to weaken, delay, or reduce the Cadillac tax until and unless it enacts an alternative tax change that would more effectively curtail cost growth.” It was signed by economists from across the political spectrum– everyone from the right-leaning American Enterprise Institute and former Bush administration officials to the left-leaning Center on Budget and Policy Priorities and former Obama advisors.

Usually if there’s a fight with a huge bipartisan group of policy wonks united on one side versus politicians and special interests on the other it’s a no-brainer: go with team wonk. But on this issue, we’re not so sure– it seems like the economists might actually be on the wrong side of this one.  

What is the Cadillac tax?

If you’ve never heard of the “Cadillac tax,” you’re not alone. It’s a 40% tax on the most expensive employer-provided health plans: plans that cost over $10,200 annually for individual coverage, or over $27,500 annually for family coverage (for retirees and those in high-risk professions, the threshold is even higher: $11,850 for individuals and $30,950 for families). These are very pricey plans– to put those figures in perspective, right now the average plan’s premiums are $6,251 for individuals, $17,545 for families.

We should also note that the tax only applies to the cost of the plan that exceeds those dollar thresholds. So if your employer’s health plan costs $11,000, only the $800 above the limit would be taxed.

Why do economists like it so much?

The U.S. is the only industrialized country where employers choose the health benefits they provide employees, which is sort of an accident of history. During World War II, the economy ramped up, but wartime wage controls prevented employers from offering higher salaries to attract workers. They could, however, offer fringe benefits, like health insurance. That, along with a 1954 law making employer-provided health benefits tax free, led to an explosion in employer-based plans: in 1940, just 9% of the country had private health coverage; by the 1960’s that figure had jumped to 70%.

Since health benefits aren’t taxed but wages are (through payroll and income taxes), employers get a lot more for their money when they spend it on healthcare. A dollar spent on health benefits gets $1 of health benefits for an employee; of $1 spent on wages only 60 or 70 cents will end up in an employee’s pocket, so employers have a big incentive to offer more generous health plans with lower out-of-pocket costs instead of higher wages. People who pay less out-of-pocket use more unnecessary health services (and more expensive health services); according to economists, this is a big reason why U.S. healthcare costs are so high.

Economists say that if we start taxing health plans, then employers won’t spend money on health benefits simply because it’s a better deal. They’ll either demand lower prices from drug companies and providers, or they’ll shift more of the cost onto employees– and with higher out-of-pocket costs employees will be choosier about the care they get, which should lower costs as well. Meanwhile the extra money employers had been spending on healthcare will go toward higher wages instead.

Well that’s the theory anyways.

Why we’re suspicious

The “Cadillac” tax will eventually hit Fords and Hyundais

The plans that will be hit by the Cadillac tax in 2018 are very, very good plans. To give an example: before this year, plans at Harvard had no deductibles or coinsurance and very low copays– yet these plans were still several thousand dollars away from triggering the Cadillac tax.

But the tax is designed to hit more and more plans over time. You might remember that last year there were a bunch of videos floating around of Jonathan Gruber, an MIT professor who advised the administration on Obamacare, saying dumb things about the new law. Many of his statements were misinterpreted, but there was one video that was revealing, even though it didn’t get a lot of attention.

The threshold for hitting the Cadillac tax is set to grow with inflation, but as Gruber explains in the video, it’s tied to the consumer price index (CPI), not medical inflation. Since medical inflation grows much faster than inflation for everything else, the cost of our health plans will grow more quickly than the trigger for the Cadillac tax, so eventually many more plans will hit it. According to the Kaiser Family Foundation, by 2028, 42% of plans could be subject to the tax; the HR consulting firm Towers Watson puts its estimate at 82% of plans.

cadillac tax projections

Shopping around in healthcare is difficult, if not impossible

For now at least, most employers are responding to the Cadillac tax simply by increasing workers’ out-of-pocket costs. Many healthcare economists would say that giving workers more “skin in the game” this way is a good thing– in theory they’ll think twice before demanding a second MRI and shop around for the best deal on the first one. But in the real world shopping around for healthcare is extremely difficult.

Last month, economists with the National Bureau of Economics Research, a private nonprofit research organization, released a study looking at what happened when one large company shifted its 75,000 workers from a plan with no deductible to one with a $3,750 deductible (workers then received that amount in a health savings account). After the switch, worker health spending dropped quickly– about 15% in a single year, which would be great news except for why it dropped. The average price of doctors’ visits didn’t decrease, meaning workers weren’t successfully shopping around for better deals– instead they were just going to the doctor a lot less. That wouldn’t be so bad if patients were simply getting less potentially unnecessary care (like those extra MRI’s we mentioned), but they also cut back on “potentially valuable care” like preventive care visits, with the sickest patients cutting back their care the most.

If you’ve ever tried shopping around for healthcare, then you probably understand why workers weren’t able to get better deals. Even if it’s not an emergency and you do manage to get accurate prices, surprise bills and the challenge of coordinating care between multiple providers can wipe out any benefit you might get from shopping around– as a growing number of healthcare writers recently discovered for themselves.

Last month, Vox’s Sarah Kliff recently wrote about her experience trying to get a better deal on an MRI for a stress-fracture on her foot. Her insurer suggested an imaging center that was cheaper than the academic medical center her orthopedist recommended, but getting the results was a time-consuming hassle, and the image itself was poor quality. Back in August, Balloon Juice’s Richard Mayhew described his own experience taking his daughter to an orthopedist: while the hospital he went to was in-network, the x-ray office in the same building was not (he only thought to ask because he works for an insurance company). And in Health Affairs, Erin Taylor and Layla Parast talked about their differing experiences giving birth at the same hospital. Layla received an unexpected bill for $1600 for anesthesiology, a bill that Erin never received. The reason? Layla happened to deliver on a day when an out-of-network anesthesiologist was on call, while Erin’s anesthesiologist was in-network. They write:

Who would have the presence of mind during labor to ask whether the anesthesiologist on call is part of her insurance network? While providing patients with information regarding which physicians are in network is an important part of health insurance transparency, it is meaningless in situations where the patient has no choice.

Keep in mind that all of these people are healthcare experts. If they had so much trouble shopping around for cheaper care, you can imagine how hard it is for everyone else.

We’re not sure that employers will try to reduce costs other ways

In an interview with Vox, Harvard University health economist David Cutler describes another ways employers might respond to the Cadillac tax besides just shifting out-of-pocket costs onto workers:

Cost sharing is the easiest way for employers to deal with this. But I think if you’re in a situation a couple of years from now, it looks a little different. Imagine if it were already here and a bunch of employers knew that if they increased the price of X drug, my tax next year would go up. I don’t know for sure, but I think it would have an effect on the conversation. I would love to see it having that kind of impact, and that might be a good impact, relative to people having higher cost sharing.

Here’s our question: haven’t employers been struggling with rising healthcare costs for a while now? If they could negotiate for better prices, wouldn’t they already have done it? And even you assume that the tax does incentivize employers to push for lower prices, Cutler seems to be saying that will only happen after employers jack up their cost sharing as much as they can.

Workers may get a raise… but not quickly and maybe not by as much as their benefits were cut

According to basic economic theory, if an employer spends less on healthcare in response to the new tax, it will eventually raise wages. If it doesn’t, then one of its competitors will, enticing the best workers away from employers who don’t. The key word though is “eventually.” As Sarah Kliff explains, “Wage increases generally take a few years to cycle into the economy, as workers switch jobs and new graduates come into the workforce.” So while you might get a raise someday, it probably won’t feel like a raise. But you will feel that big new deductible as soon as you need care.

Kliff also points out that the actual data on the connection between lower health premiums and higher wages is pretty sparse. There are no studies showing what happens to wages if you decrease employers’ health insurance costs, but other studies have found that if you raise health premiums by $1, wages don’t tend to decrease by $1. If there isn’t a dollar for dollar tradeoff in the opposite direction, it’s hard to say that cutting health costs by $1 will increase wages by $1 either. On top of that, wages are taxed, so even if an employer cuts health spending by $1 and raises wages by $1, only 60 or 70 cents will get to the worker’s pocket.

The tradeoff is only better if you’re healthy

If you’re healthy, then sure, higher wages in exchange for worse coverage are great– you’re not using the health services insurance pays for, but you would certainly use that extra cash. However, if you get sick or have a chronic health problem, any higher wages are going to go straight toward your deductible– and the way the math works out, your wage increase likely isn’t going to be as high as the increase in your out-of-pocket costs.

Isn’t economics supposed to be the dismal science?

Again, in theory a tax on healthcare might be a good idea– it does distort things when it’s cheaper for employers to provide healthcare than wages. But what if we want employers to be providing more healthcare to some workers?

We agree with Kaiser Family Foundation’s Larry Levitt: the way the healthcare system is set up now, people with high incomes probably have too little cost-sharing (because they also tend to have these Cadillac plans, with very low out-of-pocket costs) giving them an incentive to overuse medical services, while people with lower incomes tend to have too much cost-sharing. When it takes effect, the Cadillac tax will address that first part, although with some collateral damage– in addition to the wealthy, moderate income union members (like teachers) also tend to have these high value plans. But because the Cadillac tax will hit more and more plans over time, eventually it will make the problem of too much cost sharing for lower income people even worse.

To see the Cadillac tax to be a good thing, you have to make all sorts of rosy assumptions: maybe employers will implement smart deductibles that would allow people to get expensive care if they really need it, or workers will be figure out how to shop around for healthcare, or employers will get better at negotiating lower rates from providers. But it’s a weirdly optimistic take on the future from the dismal scientists– and if they’re wrong, the Cadillac tax’s lower health spending will come at the expense of workers’ health.

{ 2 comments… add one }
  • John Nagle November 22, 2015, 5:13 pm

    Interesting discussion, even though I am getting a bit bored with the healthcare mess. I’m so glad I don’t have to worry about this stuff, being on medicare.

  • Bob Hertz December 20, 2015, 8:38 am

    Thanks for a solid article, Rob.

    Two quick notes:

    a. John, there may come a time when Medicare is rationed like this, (cf the Paul Ryan budgets). Even now, Medicare is a Cadillac plan, costing about $11,000 a person.

    b. Most of the persons who have Cadillac plans today also have high wages, and are protected by seniority. (teachers, govt employees, professors, et al.) If they have to pay some higher deductibles, I will not lose sleep.

    c. The idea that the Cadillac tax might have slowed down health care inflation is the old skin in the game philosophy. This conveniently ignores the fact that millions of Canadians have no skin in the game, and yet their prices are lower than ours. Millions of Germans have comparatively tiny deductibles and again their prices are lower.

    Of course the reason is that a strong central bureaucracy conducts tough negotiation with doctors and hospitals and drug companies.

    In America we assume that this is impossible, so we turn to consumers who are supposed to be the kamikazes of cost control. I have little patience myself with this line of thought.

Leave a Comment