Tax Breakup

Employers face new opposition in their efforts to rein in health-care spending, and it's not coming from the employees whom they are forcing to foot more of the bill. Instead, employers are at odds with their allies in the conservative think-tank world, who are mounting an all-out offensive to unravel the employer-based insurance system, which covers nearly 60 percent of Americans, by proposing to tax that benefit.

The rift between the conservatives and the employers surfaced recently after a report by a bipartisan advisory commission of academics, Wall Street insiders, and former members of Congress appointed by George W. Bush to recommend tax reforms. In November, that panel, after heavy lobbying by a coalition of right-wing activists, suggested that workers' health benefits be counted as income and proposed to cap the amount of insurance that could be offered tax-free.

The tax exclusion dates to an IRS ruling in 1943 that employees did not have to pay income taxes on the value of health benefits offered by employers. The decision sparked the growth of employer-provided benefits because it gave companies a way to attract scarce workers during the war when their options were limited by government wage controls. Today it is the backbone of employer-provided health benefits. The tax exemption of health benefits saved Americans $122 billion in taxes in 2004, consultants at the Lewin Group estimate; the average family saved $1,482.

The panel's recommendation was modest in scope. But even so, it represented the first high-level push for altering the tax-free status of health benefits since the Reagan administration. “We took some sacred cows and put them into public discussion,” boasts University of Southern California professor Elizabeth Garrett, a panel member.

The commission would have recommended total abolition of the tax break, claims Grace-Marie Turner, president of the conservative health- and tax-policy shop, the Galen Institute, which helped spark the proposal, “but said they felt there was too big an infrastructure built up to recommend that off the bat and that they would instead recommend a haircut.”

Both Turner and Daniel Mitchell, senior research fellow at The Heritage Foundation, worked hard to convince the panel and its staff to propose a limit on the tax exclusion. They organized 49 conservative groups, including the American Enterprise Institute, Heritage, the Cato Institute, the Pacific Research Institute, and the American Conservative Union, to back the plan. Members of this group spent hours with commission staff lambasting the tax exclusion and sent reams of paper to support their case. Several economists from the group testified at panel hearings.

There is little sign that either Congress or the president wants to spend much political capital right now on the panel's recommendations. But Turner vows that “we're going to do what we can to keep this issue front and center.” And later this year, Treasury Secretary John Snow is expected to recommend a set of changes to the tax code. The proposed cap could be among those, or it could surface in Congress as a budget proposal.

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If and when the battle does start, the conservative think-tankers likely will be without their important natural ally: business. Employers were alarmed by the panel's proposal. National Association of Manufacturers (NAM) president John Engler called it “quite troubling.” Employer groups decried it in discussions with Capitol Hill staff. The health-insurance industry rushed to warn politicians that a tax on health benefits won't win them votes. The industry trade group, America's Health Insurance Plans (AHIP), released a survey of voters in the three early presidential primary states of Iowa, New Hampshire, and South Carolina showing that nine-tenths of respondents did not want health benefits taxed.

The proposal would cause employers administrative nightmares and create more uninsured, warns Steven Wojcik, vice president of public policy at the National Business Group on Health, which represents many Fortune 500 companies. Others fear a virtual collapse of the employer-based system. “Most of us enjoy the coverage house the tax code built so many years ago,” Neil Trautwein, assistant vice president of human resources policy at NAM, recently wrote in an e-mail to the employer and think-tank health-care community. “Damage or withdraw the twin supports (exclusion from employee income and deductibility for employers) and that house falls.”

But tearing down the employer-based system is exactly what conservative zealots want. They believe it is the fastest way to force individuals to spend their own money to directly purchase care or insurance and to understand its high costs. Immediately after the president's panel issued its report, a bevy of articles appeared on conservative Web sites saying the panel should have proposed a more dramatic plan. One, by Nina Owcharenko, a senior health-policy analyst at Heritage, called on Congress to use the opening offered by the tax panel to design an “alternative to employer-based coverage.”

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The alternative they advocate is called consumer-directed health care. That pleasant-sounding moniker was devised to feed off public resentment at the restrictions HMOs impose on enrollees. Its hallmarks are high-deductible insurance plans and health savings accounts, which mean large, out-of-pocket spending by consumers if they get sick. Its philosophical basis is that risk should not be pooled but should be entirely individual. Its proponents argue that consumers must understand the cost of health care, and that by shopping wisely, consumers can lower prices. To protect against enormous costs, they say, people can buy catastrophic insurance coverage.

Supporters of consumer-directed health care claim that workers gorge themselves on the current health-insurance system, getting too much coverage and too much care -- not because they need it, but because insurers pay the bill. The third-party payment system is “absolutely the problem,” argues Galen's Turner. Heritage's Mitchell contends that people buy health care “in a way that it's like going to an all-you-can-eat restaurant.”

Congressman Pete Stark, the ranking Democrat on a key House health subcommittee, scoffs at the notion that ordinary people can know enough medicine to decide what care to buy. “Even the richest, most educated among us doesn't know a proctoscope from a horoscope,” Stark says. “There is no way of getting the market information necessary to make economically sound choices.” You can shop for shoes or cars, he argues, but people get medical tests or treatment only when told to do so by a doctor. “When we need the expensive stuff we are scared, we are in pain, we're confused,” he adds. “All the things that make for making bad choices.”

Employers are somewhere in the middle. While many have been working closely with the conservative think-tank world to create these new insurance structures, they are not ready to jettison the existing system. “We disagree with advocates who want to force change by the big negative stick of taxation of benefits,” Trautwein wrote in another e-mail. Far better, he argued, to allow the marketplace to evolve by not restricting “employers' design options.”

Trautwein told me that proponents of consumer-directed health care “really don't understand how the insurance market works.” By having a broad group of workers in an insurance plan, employers spread the risk of huge costs for sick or older workers over a large group of people. If the healthy could drop the employer-coverage, leaving in it only the more costly workers, “you have risk selection problems,” he warns, “and employer plans crash and burn.”

Even unions like the United Automobile Workers (UAW), which has long advocated a single-payer health-care system, argue that employer-based insurance is an efficient mechanism for pooling risk. Advocates of consumer-directed health care, says Alan Reuther, the UAW's legislative director, “are really hostile to the notion of pooling risk. They think that individuals ought to bear their own risk, that it's somehow wrong for healthy people to subsidize sicker people.”

But since conservatives are having a hard time openly selling companies on this, they try to cajole them into accepting a tax cap as a way of saving money. Turner tells employers they can say to their employees, “Let's work together to stay under that cap.”
Trautwein responds that it is not just a question of cutting expenses today. Employers have a longer-term interest in having a healthy workforce. “A lot of our members are rediscovering a link between health status and productivity and safety in the workforce,” he says. Employers understand that it costs them money when workers are out sick or work without getting needed physical or mental care and are unfocused.

Business leaders have another fear: If employer-based coverage is rapidly overturned, and many employees lose coverage, there will be an outcry for national health insurance. “If we can't get the private sector to work, to adequately cover the bulk of the population … then the drum beat increases for national health care,” warns Trautwein.

Stark, a supporter of universal health care, agrees. He issued a wry press release thanking the panel for its proposal because, he says, the collapse of employer-based insurance would “push us toward universal health care. … You will not see us politicians sitting around and letting people go bankrupt.”

Hopefully it will not take the demise of the current insurance system, and the resulting pain this would cause, for that to happen. The auto industry is already feeling out Capitol Hill about government help in paying retiree health costs. Health care -- how to cover the 45 million uninsured and how to maintain it for others -- is expected to be an issue in the 2006 elections. Shoring up employer-provided health insurance, rather than taxing it to death, could be the line in the sand Democrats draw as they define a more comprehensive policy solution.

Barbara T. Dreyfuss is a freelance writer in Alexandria, Virginia.