The cost of health benefits is exempt from taxes for employers and employees. The White House Office of Management and Budget estimates that the tax exemption, which helped create the employer-based health care system during World War II, will cost the federal government $174 billion in lost tax receipts in 2009, making it a policy target for health care reform.

“This whole idea of limiting the tax exclusion will be one of the most highly contested elements of health care reform,” says James Klein, president of the American Benefits Council. “But we may see different variations on this proposal than we have in the past.”
Employers’ contributions would not be taxed. Instead, the cost of an employee’s health care would be added to total compensation and subject to federal, state and Social Security taxes.

No matter the details, employers are likely to oppose the policy, Klein says.

President Barack Obama is pushing the reform, but the first draft of bills will likely be written in the Senate, where Sen. Max Baucus, D-Montana and chairman of the Senate Finance Committee, has proposed taxing benefits in his legislation. Baucus has argued that revenue to pay for health care reform should come from within the health care system.

Republicans have also proposed eliminating the tax exclusion but have suggested providing a tax credit to individuals who buy insurance.

The proposal, however, is fraught with political obstacles. One version is likely to focus on health benefits that cost a certain dollar amount. The idea is to encourage people to elect less costly benefit plans, which would undoubtedly raise the ire of union members, whose heavily subsidized health benefits represent a large portion of their total compensation.

Another option is to tax benefits of people at a certain income level. But employers fear that Congress could lower that level anytime it wanted to raise revenue.

“It’s a blunt policy instrument,” Klein says.

In a policy brief in January, the Employee Benefit Research Institute wrote, “The change would be especially difficult for self-insured employers that do not pay insurance premiums, since they would have to set the ‘premium equivalent’ for each worker. This would not only be costly for employers, depending upon the requirements set out by law, but could also create fairness and tax issues for many affected workers.”

No concrete details are expected until the spring, when the legislation is set to go before the Senate committees on health care and finance.

“There’s absolutely no question that it’s on the table,” says Susan Relland, an attorney with Miller & Chevalier in Washington. “But we have no details yet.”

—Jeremy Smerd

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