Eliminate 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 fully eliminates the income tax exclusion and includes the full value of ESI in taxable income for the individual income tax. This would increase the tax burden on labor income across the income spectrum, reducing returns to labor, hours worked, and economic output. It would improve the neutrality of the tax code by treating ESI the same way as wages and salaries. The reduction in the federal budget deficit would reduce federal government borrowing as well as interest payments to foreigners, offsetting some of the decline in GNP.

On a conventional basis, this option would decrease the primary deficit by $3,580.7 billion over the budget window. Long-run GDP would fall by 1.1 percent, and long-run GNP would fall by 0.8 percent. On a dynamic basis, the primary deficit would decrease by $2,419.7 billion from 2027 through 2036, $1,161.0 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 157.9 percent by 2056.

On average, in 2036, taxpayers would see decreases in their after-tax incomes of 1.8 percent. The top quintile of taxpayers would experience a 2.0 percent decrease, and the bottom quintile would also experience a 0.2 percent decrease. On a long-run dynamic basis, taxpayers would see a 2.6 percent decrease on average.