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Why economists love Obamacare's tax on expensive health insurance, explained by an economist

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The Cadillac tax does not have many defenders in Washington. It’s the one major part of Obamacare that Hillary Clinton wants to repeal — and Republicans, unsurprisingly, would be gleeful to see it killed.

The tax's main defenders are economists. That includes people like Harvard University’s David Cutler. He sees Obamacare’s tax on the most expensive health insurance plans as a way to constrain the growth of health-care costs. Right now in the United States, employer-provided health benefits aren't taxed as income the way cash wages or most other in-kind benefits are. Cutler argues that if that changed for the most expensive plans, insurers and employers would take more aggressive steps to constrain premiums. They might push back more against expensive drugs or hospital procedures.

Cutler advised President Obama’s 2008 campaign on health policy, and wrote some memos advising the White House on the health law’s implementation. We spoke Thursday about why he supports the tax, how Americans can expect it to raise their wages, and why he disagrees with Clinton on her stance. What follows is a transcript of our discussion, lightly edited for clarity.

Sarah Kliff: There are a lot of people who dislike the Cadillac tax and how it will change health care in the United States. Can you walk me through why it’s a policy idea you support?

David Cutler: Economists thought this was important not because of the revenue it would raise, but because of the incentives it would create. You’ve seen a lot of companies getting rid of generous insurance policies and making them less generous [in preparation for the tax to hit in 2018]. Not that it’s always bad to have generous plans, but the idea is you shouldn’t just have more insurance because the tax code subsidizes that.

SK: So here’s where I think the public gets frustrated — that they don’t see any upside of having their benefits pared back, that they just get a raw deal and worse benefits, and why should they get behind that?

DC: So here’s an example of where this could be very good for consumers. One thing that’s happened recently is we’ve had the prices of drugs go up very quickly. Right now, that gets dumped onto patients. But imagine if we were in a world where the new prices from pharma were ones that employers would have to pay a tax on. Then you’d have every employer saying, Why are these prices so high? What are we going to do about that? Maybe we should encourage more generics. It would bring another pressure to the conversation, and I think that would be a very good thing.

SK: But that’s not what’s happened, at least not yet. Insurers haven’t really used the Cadillac tax as a reason to negotiate lower prices. They’ve just accepted prices are high and decided to create higher cost sharing, like more copays and deductibles.

DC: 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.

More generally, I hope one thing it will spur is smarter cost sharing. Take the example of a routine pregnancy [where the risks of the procedure are quite low]. Generous health insurance plans charge patients a low price for all hospitals, regardless of how much the hospital charges. In high-deductible insurance, the plans charge a high price even for the cheap hospitals.

The smarter cost sharing there would be to make it cheap for high-risk people to go to the expensive teaching hospital, because they actually require more complicated care. But you'd want to make it more expensive for the routine pregnancy. People could choose to go to the more expensive hospital, too, but they'd have to pay a higher price.

SK: One argument that gets made in favor of the Cadillac tax is that it will result in higher wages, as employers will move the compensation they had planned to give as insurance over to paychecks. How strong is the evidence on that? And is it something people will feel individually, or more an economy-wide effect?

DC: It’s true we don’t have this exact experiment [of what happens when spending on health benefits falls], but the evidence of the offset between health benefits and wages is about as strong as it is in any area. So I’d be surprised if it didn’t happen here. Employers are so used to thinking about total compensation packages. They’ve been linked together a lot. You’ll hear things like employers saying, "We’re sorry wage increases are limited because health costs have gone up a lot."

SK: So this is something that workers should feel directly, if wages play out as the research suggests?

DC: They should be able to see that, although it might not be assigned to health-care costs. In the 1990s, for example, wages increased really rapidly and health costs grew slowly. Those were linked, but very few people, in their minds, would say, Gee, my higher wages are probably due to health costs growing slower.

SK: What did you think of Hillary Clinton’s proposal to repeal the Cadillac tax and raise the revenue elsewhere?

DC: I obviously disagree with her on this particular point. I think the primary reason for the tax is not the revenue. It’s the incentives it creates.

Nowhere does our letter argue that the Cadillac tax is optimal. There’s not a single person who would say this is the best way to do this. I would absolutely support something that could make it work better. But that’s different from saying we should get rid of it if we can find the revenue elsewhere.

There are two ways you can think about fixing health care. You can change the incentives for buyers and for providers. So far, much of the payment reform for providers is going better than CBO [the Congressional Budget Office] thought, and we should step on the gas with that. I think Clinton has said as much, and others believe as much.

At the same time, getting rid of the Cadillac tax would be stepping off the gas on the incentives for patients. My own personal sense is that incentives for providers are more important, so the Cadillac tax isn’t a make-or-break issue for me. But it’s a helpful thing, and if we want to focus on spending and efficiency, I think it would be helpful to have.