Cap on Employer Tax Exclusion for Employee Benefits Almost Assured.

For federal income tax purposes, employers may deduct the cost of health insurance provided to employees. Employees may also exclude the value of this benefit from their income. The “cost” of the exclusion in 2007 was about $134 billion (OMB, Analytical Perspectives FY2009 (PDF)). The exclusion also means that Social Security and Medicare taxes are not paid on this employee benefit; this “cost” is not measured by the government.

No wonder that eyes are now being turned to this employer exclusion as a way to pay for healthcare reform proposals, but it is not a popular idea. A Washington Post article published today noted that the Democratic Congress summarily dismissed the idea two years ago when President George W. Bush included it in his budget request, and that many senior House Democrats continue to oppose the idea, arguing that it could be catastrophic at a time when companies are scaling back coverage for their workers and dropping it completely for retirees.

Still, as noted in the Post article, many economists and tax analysts have long argued for changing current tax law on health coverage, which some say disproportionately benefits wealthier workers. The law also may encourage people to enroll in the most comprehensive health plans on offer, the so-called Cadillac plans that provide vast coverage, mask the true cost of health care and contribute to skyrocketing costs.

Republicans we talked with last week on Capitol Hill seemed to be looking for ways to tap this employer exclusion to at least equalize the tax benefits between those who receive their health insurance from employers and those who purchase their own health insurance.

As the Post points out, many lobbyists and others involved in the health-care debate say they see few other places to go for the kind of money that will be needed to meet Obama’s demand for ambitious change. In their view, the question is not whether employer benefits will be taxed but how much of the benefit will be spared.

Based on what I heard on the Hill last week, I would agree that there will at least be a cap placed on the employer tax exclusion in any healthcare reform legislation that might be passed this year.

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