Cap the Employer-Sponsored Health Insurance Income Tax Exclusion

The tax code contains several preferences for health care, and the largest is the tax exclusion for employer-sponsored health insurance (ESI) premiums. The exclusion for ESI has been in place since World War II, and it incentivizes employers to shift pay packages toward untaxable ESI benefits rather than taxable wages and salaries. The exclusion distorts the labor market and the healthcare market, as it favors costly insurance coverage tied to employment rather than coverage that travels from one job to the next or direct payments to healthcare providers.

This option imposes a cap on the tax exclusion beginning at the 80^th percentile of premiums, subjecting premiums over $14,816 for single plans and $38,185 for family plans to the income tax. The thresholds would be adjusted for wage growth moving forward. The tax increase would be concentrated on upper-income taxpayers and would increase the marginal tax rate on labor income. Hours worked and economic output would therefore fall. Treating at least some portion of ESI the same way as wages and salaries would improve the neutrality of the tax code.

On a conventional basis, this option would decrease the primary deficit by $318.5 billion over the budget window. Long-run GDP would fall by 0.1 percent, and long-run GNP by less than 0.05 percent. On a dynamic basis, the primary deficit would decrease by $242.6 billion from 2027 through 2036, $75.9 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 174.0 percent by 2056.

On average, in 2036, taxpayers would see decreases in their after-tax incomes of 0.2 percent. The top quintile of taxpayers would experience a 0.3 percent decrease, whereas the bottom quintile would experience no change. On a long-run dynamic basis, taxpayers would see a 0.2 percent decrease on average.