Eliminate the Employer-Sponsored Health Insurance Payroll Tax Exclusion

The tax code contains several preferences for health care, and the largest is the income and payroll 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.

This option fully eliminates the payroll tax exclusion and includes the full value of ESI in taxable income for the payroll tax without changing the current $184,500 (inflation-adjusted) wage cap. This would increase the tax burden on labor income, reducing returns to labor, hours worked, and economic output. Some taxpayers, however, would see a reduction in marginal tax rates because including the value of their employer-sponsored health insurance in the payroll tax base would put their total income above the wage limit, offsetting some of the negative effect on output. Eliminating the payroll tax exclusion would improve the neutrality of the tax code by treating ESI the same way as wages and salaries for payroll tax purposes.

On a conventional basis, this option would decrease the primary deficit by $1,834.5 billion over the budget window. Long-run GDP would fall by 0.2 percent, and long-run GNP by less than 0.05 percent. On a dynamic basis, the primary deficit would decrease by $1,610.5 billion from 2027 through 2036, $224.0 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be lower than baseline, reaching 163.4 percent by 2056.

On average, in 2036, taxpayers would see decreases in their after-tax incomes of 0.9 percent. The top quintile of taxpayers would experience a 0.6 percent decrease, while the bottom quintile would experience a 0.5 percent decrease. On a long-run dynamic basis, taxpayers would see a 1.0 percent decrease on average.