The idea of taxing high cost plans is relatively new, and there are many outstanding questions about how it would work. For example, how exactly how would this excise tax raise revenue? The Senate plan imposes a 40 percent excise tax on high value plans with a cumulative cost of more than $21,000. But medical loss ratios for private health insurance plans easily exceed 60 percent of premiums, so insurance companies confronted with a 40 percent excise tax will simply stop issuing those plans.

 

At the employer level, that means if an employer used to offer his employees a $30,000 package of health benefits, he will now offer them a $21,000 plan and pay the remaining $9,000 to them in the form of wages and non-health benefits. These extra wages, in turn, are subject to income and payroll taxes, resulting in higher tax collections by the federal government.The revenues raised from the excise tax come from higher income and payroll taxes on employees, not from excise taxes on insurance companies.

It’s this aspect of the Senate plan that has unions united in opposition. The excise tax is coupled with a refundable tax credit available to families making less than 400 percent of the federal poverty level (about $88,000 for a family of four). But many union members make more than that while most union members enjoy health insurance benefits that exceed the Baucus threshold. So for many union members, the Baucus plan would reduce their health benefits and raise their income and payroll taxes, but exclude them from the refundable tax credit.

What about S Corporations? How would they be impacted? Here’s chart we put together:

Earns More than 400% FPLB Earns Less Than 400% FPLB
Has High Cost Plan Taxes Are Higher Mixed
Has Low Cost Plan Not Affected* Taxes Are Lower*
We put an asterisk by the “low cost plan” results because of another quirk in the excise tax that deserves review, the indexing for its thresholds. As we mentioned, the Baucus bill sets the initial threshold for a family’s high cost plan at $21,000. This threshold includes all forms of health care spending — premiums, preventive care, flexible spending accounts — and is indexed not to health care inflation (about 8 percent), but to regular inflation plus one percent (about 3-4 percent). That means over time, the value of your low cost insurance plan is going to catch up to the threshold and become subject to the tax.
This aspect of the Baucus plan would have been fixed had it not been essential to the procedural challenges facing health care reform. Simply put, both the House and the Senate are attempting to offset health care spending, which grows at 8 percent per year, with tax increases, which rise at five percent per year. The costs of the plans grow faster than the offsetting taxes, resulting in deficits in the out years.
By comparison, the Baucus tax, because of the indexing details, grows faster than health care spending and produces surplus revenues in the out years. As much as the unions complain, coming up with an offset that keeps the President’s and congressional leadership’s promise not to make the deficit picture worse is going to be hard to find.
Thus, the friction between the House and Senate tax offsets, and yet another obstacle between healthcare reform and a signing ceremony. The House surtax targets closely held businesses while the excise tax targets union workers. Nobody said raising taxes by half a trillion dollars would be easy.

Estate Tax Update

We expect Round 1 in the great estate tax battle to take place this fall/winter. The tax goes away in 2010, and then returns in full form in 2011, giving just about everybody a reason to come to the table.

In preparation for this debate, forty-six trade associations, including your S Corporation Association, the Chamber of Commerce, NIFB, and the National Association of Manufacturers sent a letter to Congress urging them to support a permanent estate tax fix that includes a 35 percent top rate and a $5 million per spouse exclusion.

As Martin Vaughn of Dow Jones reported:

The groups said they will support a permanent rate of 35%, with the first $5 million of wealth exempted, and up to $10 million in the case of married couples. Those are the terms that are being pushed in the Senate by Sens. Jon Kyl, R-Ariz., and Blanche Lincoln, D-Ark.

On timing, the expectation continues to be that Congress will take up legislation to extend certain expiring tax provisions before the end of the year, and that the estate tax fix will be made part of that bill.

Tax Reform Panel Report Update

Remember the President’s Economic Recovery Board headed by Paul Volcker? The President announced its creation at the beginning of the year but it’s been quiet since then. The principle reasons for this silence are federal sunshine laws that require any gathering to be open to the public. It is hard to provide the President with critical insights into how to fix the economy when the whole worlds watching.

One offshoot of the Board that has been active is the White House Tax Reform Panel. They had their first (and last?) public meeting last week, chaired by CEA Member Austan Goolsbee. During the meeting, Goolsbee made clear that the Panel was not seeking to create a new tax system but rather would focus its recommendations on three specific areas — tax simplification, enforcement and corporate tax reform. The panel is accepting public comments through October 15th and then will make its own recommendations known to Treasury Secretary Geithner by December 4th.

In the past, it has been easy to dismiss the work of presidential or congressional tax reform panels. They tend to come and go, after all, with little to show for their efforts. This time, however, the combination of huge deficits and an expiring tax code make some sort of dramatic changes to the tax code almost a certainty. Given the landscape, we intend to follow the efforts of this group closely.