December 29, 2015

Five Lessons of the Cadillac Plan Tax Failure

Charles Blahous

J. Fish and Lillian F. Smith Chair
Summary

The omnibus spending bill recently passed by Congress and signed into law by President Obama delays the onset of the Affordable Care Act (ACA)’s so-called “Cadillac plan tax” for two years. The new law also weakens the effect of the tax (assuming it’s ever collected) by making it deductible, as noted by my Mercatus Center colleague Brian Blase. I agree with former OMB director Peter Orszag’s observation that the delay may simply be a first instance of a “rolling permanent deferral” of the Cadillac plan tax.

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The omnibus spending bill recently passed by Congress and signed into law by President Obama delays the onset of the Affordable Care Act (ACA)’s so-called “Cadillac plan tax” for two years. The new law also weakens the effect of the tax (assuming it’s ever collected) by making it deductible, as noted by my Mercatus Center colleague Brian Blase. I agree with former OMB director Peter Orszag’s observation that the delay may simply be a first instance of a “rolling permanent deferral” of the Cadillac plan tax.  

The tax has long been on shaky political ground and the new law considerably reduces the chances of its ever taking effect.  It is worth understanding what caused the unraveling of the tax, and what lessons can be drawn from this.

The Cadillac plan tax is (was) a 40% excise tax on the amount by which health insurance plan costs exceeded annual thresholds of $10,200 (individuals) or $27,500 (families), starting in 2018. These thresholds were indexed to grow more slowly than historical health cost growth, so that over time more and more plans would be subject to the tax, producing escalating federal revenues necessary to help fund the ACA’s ambitious health entitlement expansion. A key policy intent of the tax was to offset the damaging effects of the longstanding federal tax preference for employer-sponsored insurance (ESI), one of which is to drive excess health cost inflation.  

Lesson #1: Save before you spend. After the ACA was enacted, I expressed concern that “the legislation employs comparatively uncertain cost-saving measures as budgetary offsets for comparatively certain cost-increasing provisions.” My observation was hardly original nor was the concern applicable only to the ACA. Legislators have a long history of enacting laws spending certain funds right away, purportedly financed by less-certain savings scheduled to take effect later.  This rarely works as advertised.

Regardless of one’s view of whether the ACA’s particular savings measures were ever likely to pan out, my other observation from that paper remains a broadly applicable legislative principle: “The proceeds of such cost-savings cannot safely be spent until they have verifiably accrued.” This principle was not heeded with the ACA.

Lesson #2: Don’t assume a favorable future political alignment. The ACA was passed during a rare historical moment in which Democrats held the White House, the House, and a wide majority in the Senate. The long-term fate of the ACA’s individual provisions was always more likely to be a function of how a differently constituted future Congress might view them. As Orszag has noted, even Congressional Democratic support for the tax collapsed after Congress switched hands.

This writing was on the wall for the Cadillac plan tax as soon as it was enacted. I noted in 2012 that “it did not survive its initial clash with political pressures; the form of the tax enacted with the ACA was almost simultaneously amended in accompanying reconciliation legislation, changes that both postponed the effective date and increased the thresholds below which the tax would not apply.” Thus, “to assume that the tax will always be applied to the letter of current law is to assume that political actors in the future will be far more committed to this tax than even the original authors of ACA were.”

Lesson #2 is closely related to Lesson #1’s admonition about fiscal prudence because it’s much easier for an incoming party majority to attack a previously-enacted tax than it is to repeal benefits on which people have become dependent.  In any case, no successful legislative strategy can be built upon the assumption that a rare political majority will persist.

Lesson #3: Be transparent.  A key policy purpose of the Cadillac plan tax was to “offset some of the excessive spending that economists attribute to the longstanding tax preference for employer-provided insurance.” The most direct and transparent way to address that problem would have been to scale back that tax preference.  But instead of straightforwardly attacking the distortion and its damaging effects, the Cadillac plan tax was an opaque attempt at devising a countervailing distortion.  

This opacity received negative attention when videos surfaced of ACA architect Jonathan Gruber asserting that he and other proponents engaged in “mislabeling” to invisibly achieve the Cadillac plan tax’s policy goals. But apart from ethical considerations, deliberate opacity is often a tactical mistake. A transparent debate over scaling back the ESI tax preference would undoubtedly have been contentious, but those who supported such a provision would thereafter have been publicly invested in the objective. But instead of reflecting a growing bipartisan consensus on the necessity of attacking tax preferences, we wound up with a new tax that had few friends. The opacity created a situation in which support was largely confined to a small community of experts who had bought into the tax’s purpose, while powerful constituencies on both sides of the aisle rose in opposition.

Lesson #4: Partisan victories can be short-lived.  Politically difficult measures like the Cadillac plan tax are much easier to defend if enacted with bipartisan support. If on the other hand legislation is passed over the strong and unified objections of one of the two major parties, it’s often only a matter of time before that party has an opportunity to repeal strongly disliked parts of that legislation. Had the Cadillac plan tax (and other parts of the ACA) been bipartisan its political staying power would likely have been greater.

Contrast the ACA dynamic with, for example, bipartisan legislation such as the 1983 Social Security reforms. Those controversial reforms were extremely difficult to enact but once they were, negotiators on opposite sides were heavily invested and thus disinclined to revisit the legislation – even when tough explicit measures like taxing Social Security benefits and raising the retirement age were taking effect.

Lesson #5: Don’t campaign against necessary policy steps. The ACA was enacted after presidential candidate John McCain had been successfully attacked for his proposal for to scale back the ESI tax preference – even though experts on both sides understood his basic idea to be a necessary policy step. When this happens, those elected to office find themselves with a bad choice between breaking their word and furthering large policy problems. A core reason we now lack an effective mechanism to constrain the drivers of excess health cost inflation is that prior to the ACA it was not adequately presented to voters what that might involve. While it’s inevitable that candidates for office will want to present their platforms in the most salable light, they would do well to campaign in a manner consistent with how they need to govern. And voters, for their part, should be scrutinizing candidates for whether their promises can realistically be upheld if elected to office.

The apparent demise of the Cadillac plan tax contains many object lessons for legislative strategists. Crafting a more effective brake on health cost inflation will require that we learn from them.