The misguided health care excise tax

NEW YORK (Fortune) -- The idea of an excise tax on "Cadillac" health care plans sounds like magic. It would raise $150 billion over 10 years to help finance healthcare "reform;" it would be paid by employers, insurance companies, and "the rich;" it would help "bend the cost curve" in the future; and for all I know, it might help re-grow hair and cure warts.

But if you look at the actual workings of the plan, you come away far less impressed with this tax.

You discover that more than 80% of the money it raises would come from individuals paying higher income, Social Security, and Medicare taxes, not from soulless employers and insurers (is there any other kind?).

You also discover that the biggest portion of the money comes from people in the $100,000 to $200,000 income range. That's not exactly rich -- especially not for those of us in high-cost areas on the East and West coasts.

I'm not getting this information from some secret source passing me documents in a parking garage -- it's from an analysis last month by the staff of Congress' Joint Committee on Taxation for Rep. Joe Courtney, D-Conn. Courtney opposes the tax, but that doesn't impact the numbers because the committee's staff is a well-respected, non-partisan operation.

The tax is projected to raise $149 billion for the 10 years ending in 2019 (on page 4, for those of you tracking this online). Only $26 billion of this -- less than 20% -- would come from payment of the excise tax itself. The rest, more than 80%, would come from higher income, Social Security, and Medicare taxes from individuals.

If you eyeball the last eight pages of the report -- which are confusingly numbered 1 through 8 -- you see that the biggest number of tax dollars come from people in the $100,000 to $200,000 income range. You also see that the impact on people in the $1 million-plus range -- most of whom probably really are rich -- is relatively trivial.

Okay. Why would employees be paying higher taxes on their income because of an excise tax on health care? I'm glad you asked. Even though the report doesn't answer that question, I will.

Here's the deal. Economists at the joint committee and most other places assume -- I'll repeat that, assume -- two things. First, that to avoid this tax, employers will shell out less in health-care costs than they otherwise would. Second, that the money employers don't pay on health care will go to employees as higher salaries.

Hello? Call me skeptical -- or cynical -- but I find it hard to believe that any employer would pay more to employees if it paid less for health care. But economists assume that over the long run, employers commit certain amounts to compensation, and will pay more in salary if health care cost less.

I also find it hard to believe that employers can work any harder than they already are to holding down health-care costs. That's the assumption underlying the idea that the tax will hold down future costs.

I'm sure that the people who believe in the virtues of the tax are acting in good faith. I just think that the real world of health care is different than their theoretical one.

It's possible that companies that pay less in health care would pay more in corporate income taxes because their income would be higher. But given how good companies are at avoiding taxation, who knows?

As an aside, I think (but can't definitively say) that some of the extra taxes would come from employers cutting back or eliminating health care flexible spending accounts.

FSAs, as they're known, allow workers to set aside pre-tax income to pay for medical expenses, such as co-pays and over-the-counter drugs, which aren't covered by insurance. But employers, who now pay little for FSAs except for administrative costs, would be forced to pay a 40%, non-tax-deductible excise tax on part of employees' FSA accounts if a plan's expenses (total employer and employee premiums plus FSAs plus medical savings accounts plus "wellness" programs) exceeded certain thresholds. Employers won't offer FSAs if there's a chance they'd have to pay excise tax as a result. This would increase workers' taxable incomes.

I'm not sure if FSAs (which I use to the max) are good public policy. Ditto for medical savings accounts. But if we want to eliminate or trim back these accounts, let's have an open discussion, not do it through the back door.

In case you're interested: no, this tax wouldn't affect me in any serious way. And no again, I'm not a catspaw for organized labor, which is opposing the tax. I just think it discriminates unfairly against people who are more expensive to insure because they're older, live in high-cost areas, or both. But if this excise tax can re-grow hair...as a member of the follically-challenged set, I'm willing to take another look.