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April 09, 2013 The Tax Lawyer

Sometimes That Cadillac Is a Lemon: Why the High-Cost Health Insurance Excise Tax Needs a Tune-Up Before Implementation

Vol. 66, No. 1 - Fall 2012

Eleanor Hagan


    Efforts to achieve national health coverage in the United States have been longstanding, elusive, and contentious. For more than 80 years, reformers have attempted to expand access to health services and to make them affordable to more people. With costs soaring and 46 million people without insurance, the necessity and means of reforming health coverage in the United States became a significant issue in the 2008 presidential election.

    During the campaign, both John McCain and Barack Obama recognized and campaigned on the need for major health care reform in the United States, although they tended to focus on different ends for those reforms. Senator McCain’s plan focused on curtailing the soaring costs of health care in a system that he described as a “perfect storm” of problems, principally by changing the tax treatment of employer-sponsored insurance (ESI). Senator Obama’s plan focused on increasing access to affordable health insurance, which he viewed as the right of every American. These two goals—cost containment and expansion of access—have been at the heart of most of the reform efforts over the past century. Ultimately, both underlie the Patient Protection and Affordable Care Act and the Reconciliation legislation (collectively ACA), which were passed by Congress in 2010 in the wake of the 2008 presidential election, and which has generally been viewed as the culmination of the previous 80 years of health care reform efforts in the United States.

    As the provisions of the ACA—now upheld as constitutional by the Supreme Court—come into full effect, profound changes will occur to the nature of the health care system in the United States. Gone is the ability for insurers to exclude individuals from insurance on the basis of a preexisting condition. Medicaid has been expanded, and children up to the age of 26 are allowed to stay on their parent’s health insurance. Under the “individual mandate,” Americans will be required to purchase health insurance or face a tax penalty. In order to help them afford this mandated coverage, certain low-income taxpayers will receive a refundable tax credit paid directly to their insurer to help cover the cost of their premiums. To keep out-of-pocket expense low, some low-income taxpayers will additionally get reduced costsharing, paid for by the federal government.

    The cost in federal tax revenue lost under the ACA must be offset either by increases in tax revenues or by cuts in spending. Following the reenactment of the Statutory Pay-As-You-Go Act (PAYGO) in February 2010, Congress was required to offset any increase in mandatory spending with an increase in taxes or a cut in mandatory spending. President Obama also demanded that a health care overhaul not add to the federal deficit. Thus, alongside the reforms to the insurance market are several revenue-raising provisions that will help pay for the former’s implementation. Among these is an excise tax on high-cost health insurance plans, the so-called “Cadillac Tax.”

    Although the Cadillac Tax is not scheduled to come into effect until 2018, the tax is already having an impact on companies that must follow accounting guidance and estimate the impact of the Cadillac Tax on their post-retirement benefit obligations. The purpose of this Comment is to examine the efficacy and equity of the use of the Cadillac Tax in health care reform and to urge for its retooling before it is actually levied.

    This Comment argues that while the Cadillac Tax would counteract some of the concerns at the heart of the current treatment of ESI under the Code, it does so in a manner that is inequitable and inefficient. This Comment concludes that an alternative model should be designed that is more sensitive to the valuation of health insurance.

    Part II provides a historical overview of the evolution and tax treatment of ESI in the United States. Part III.A explains the concerns underlying changing the tax treatment of ESI in relation to health care reform. Part III.B details the functioning of the high-cost plan excise tax as it is written. Part III.C examines how the current functioning of excise tax is neither an equitable nor efficient means of effectuating reform of the tax treatment of ESI. Part IV suggests that an alternative model of meeting these ends may be found by analogizing to the tax treatment of employer-sponsored group term life insurance plans and will suggest a means by which the tax might be retooled.

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