Health tax break: Sacrosanct no more

Employer contributions to pay for health insurance are tax-free to employees. But they may not stay that way, at least for some.

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By Jeanne Sahadi, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- Get ready. Washington is again debating how to fix the health care system. And the outcome might affect your wallet.

The discussions are just beginning and much remains undecided. But expect at least one thing: To help pay for changes and reduce overall costs, lawmakers will consider curbing the tax benefits that employees enjoy when they get their health insurance plans through work.

Here's the crux of the issue: President Obama wants to create a $634 billion fund to pay for health care reforms. Leading lawmakers appear willing to go along, but they're not keen on how he has proposed to pay for a big part of it. Obama wants to cap how much of a deduction high-income taxpayers may take. The administration estimates doing so could raise $318 billion over 10 years.

The Senate's top tax writer, Max Baucus, D-Mont., who is also leading the push for health care reform, has asked White House budget chief Peter Orszag to consider instead changing the tax break that employees receive when their employers foot part of the bill for their health insurance.

Right now the portion of premiums paid by employers is treated as tax-free compensation to employees. And there is no limit on how much employers may contribute.

Some lawmakers have proposed eliminating the exclusion entirely and replacing it with a tax credit or deduction.

But Baucus isn't in that camp. "I do not favor eliminating it ... and I don't think that's where the vast majority of Congress is either. But I do think it needs to be trimmed, limited, looked at," he said at a presentation at the Kaiser Family Foundation earlier this month.

While the president doesn't support the idea of taxing employees on employer-provided health benefits -- and in fact, promised during his campaign that if elected nothing would change for employees who get their insurance through their jobs -- administration officials have indicated in different forums that no idea is off the table when it comes to health reform.

What a cap may ... or may not ... do

The health care exclusion is the federal government's single biggest tax expenditure. In other words, Uncle Sam forgoes more potential tax revenue from this tax break than any other. The exclusion was worth $246 billion in potential revenue in 2007, according to the Joint Committee on Taxation. That number is expected to increase every year as health care costs rise.

But imposing a cap isn't likely to raise anywhere near that kind of money although it may lower costs in the long run because of that old show stopper: human behavior.

"The goal of the cap is to get people to buy less comprehensive plans," said Paul Fronstin, the director of health research at the Employee Benefit Research Institute.

Translation: Workers who have to start paying tax on a portion of their health care compensation may opt for lower-cost, less comprehensive plans to escape having to pay any tax. And that would curb how much revenue the federal government could raise overall.

"When they get down to the numbers, it won't raise as much money [as they might need]," Fronstin said.

Figuring out what's fair

Questions of fairness will play a role in the debate over whether and where to cap the exclusion and on whom.

One of the criticisms of the work-based tax break is that it disproportionately benefits high-income employees, because they pay the highest tax rates and the value of the exclusion is based on an employee's top tax rate.

One idea under consideration is to impose a cap that "wouldn't affect the majority of Americans," a Baucus aide told CNNMoney.com. The aide didn't specify whether that meant only high-income taxpayers, only those in the very highest-priced plans or some other group.

Another criticism is that the work-based tax break disproportionately benefits those who buy very expensive and comprehensive plans. The thinking is that Americans aren't aware of the true cost of health care plans because they only pay for a portion of their plans, so they're not likely to be cost-conscious when it comes to deciding on their insurance, treatments or drugs.

"The goal of capping the tax exclusion is to tax Cadillac plans, but it won't just tax Cadillac plans," Fronstin said.

By that he means Cadillac plans aren't the only ones that are expensive.

The cost of employer-based insurance plans is dependent on a number of factors, including the average age of the participants. So, a younger worker at a company where the average age is 55 will pay more for the same plan as she would if she worked at a company with a younger employee base. The same applies if she lives in the Northeast, where health insurance is more expensive, or if she works for a small business.

"Those disparities exist now, but you're not being taxed on them," Fronstin said. To top of page

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