Jonathan Gruber's Real Mistake

By John S. Hoff

The problem is not that he took money from the administration. It’s that he’s just wrong.

In a recent op-ed in the Washington Post, MIT economist Jonathan Gruber defended the tax on “Cadillac” plans in the healthcare overhaul bill passed by the Senate. The tax is supported by the administration. The op-ed did not disclose, as has since become known, that Gruber has received almost $400,000 under a consulting contract with the administration while touting its healthcare proposals.

The failure of the op-ed to disclose this compensation arrangement may be poor judgment. But Gruber’s analysis of the merits of healthcare overhaul and of the Cadillac tax is the greater error.

Gruber argues that the tax is not a new tax because it would simply eliminate the special tax break for health insurance that workers receive from their employer. He argues this new tax “is almost universally favored by health policy experts.”

Workers may be more heavily insured than if the tax treatment were neutral.

This is not true. Gruber has wrongly translated experts’ view that the tax treatment of employer-provided insurance should be reformed into support for the Cadillac tax in the Senate bill. The proposed Cadillac tax he supports is a politically crafted device that goes in the opposite direction from what the policy experts advocate.

Here’s the issue. When an employer provides health insurance, the value of that insurance is not included in workers’ taxable income, even though it represents compensation. The employer can deduct the cost of the insurance from his taxable income as compensation paid, but the workers do not include it in their taxable income. This is a historical accident, going back to wage and price controls during World War II. As Gruber points out, the estimated amount of tax revenues forgone because of this exception to the usual rules for taxing compensation is at least $250 billion per year.

Most policy experts believe that this open-ended tax benefit for employer-provided insurance distorts the healthcare system and inflates costs. It encourages workers to take compensation in the form of tax-preferred health insurance rather than cash wages. As a result, workers may be more heavily insured than if the tax treatment were neutral. This disguises the cost of care and reduces the incentive to mind costs. The exclusion, as it is called, supports a system that prevents workers from owning their insurance and being able to keep it if they change jobs. It discourages the development of long-term relationships with the insurer. And it is regressive: the higher the workers’ income and the richer their insurance package, the greater the tax benefit.

The amount of tax revenues forgone because of this exception to the usual rules for taxing compensation is estimated to be at least $250 billion per year.

Health policy experts, therefore, have suggested substituting for the exclusion a voucher or tax credit (which could be larger for people with lower income) for people to buy insurance. This would assist everyone in buying insurance—whether they get their insurance at work or on their own—and also allow them to carry their insurance from job to job. With a direct and visible economic stake in their health spending decisions, people would be more cost-conscious purchasers.

But the Cadillac tax does not address the exclusion and is the reverse of what policy experts have proposed. Gruber has wrongly taken experts’ support for one reform and misleadingly used it to support a proposal contrary to their position.

The Cadillac tax would be imposed in the service of a massive government takeover of insurance that would homogenize insurance plans by government directive, reduce the incentive and ability of insurers to innovate, and greatly restrict individuals’ ability to choose their own insurance. People would be required to purchase the insurance set by the government. They would not be able to buy plans with higher deductibles or that did not cover services they would not use. They would be required to buy more comprehensive, and thus more expensive, plans than they might choose on their own.

Most policy experts believe that this open-ended tax benefit for employer-provided insurance distorts the healthcare system and inflates costs.

The proposed new tax would not encourage cost-conscious behavior. The tax—40 percent of the cost of benefits in excess of $8,500 for individuals and $23,000 for families—would be paid by employers and insurers. Paying the tax would likely increase the cost of all insurance, not just the Cadillac plans. The tax would be invisible to individual workers—who actually receive the care—and would not make them more cost conscious.

In fact, the ability to hide the tax from individuals is what made this tax attractive to senators. And it is precisely the reason that most policy experts who call for reform of the current tax treatment of employer-provided insurance to encourage greater choice by families oppose this contrived Cadillac tax.

The Cadillac tax will likely increase healthcare costs. It fails to give individuals choice. It does not address the tax exclusion for employer-provided insurance. It does not introduce more cost-effective incentives into the healthcare system. And it is intended to fund a government takeover of the healthcare system. It is the wrong way to reform the healthcare system.

John S. Hoff, a lawyer and trustee of the Galen Institute, was a deputy assistant secretary in the Department of Health and Human Services.