The Looming "Cadillac Tax" of the ACA

TaxOne of the most significant, and controversial, provisions of the Affordable Care Act is the new excise tax on high-cost health plans proposed to both slow the rate of growth of health costs and finance the expansion of health coverage. The provision is often called the "Cadillac" tax because it targets so-called Cadillac health plans that provide workers the most generous level of health benefits. These high-end health plans' premiums are paid for mostly by employers. They also have low, if any, deductibles and little cost sharing for employees.

The excise or Cadillac tax was designed to address three major goals: help finance health reform, especially the Affordable Care Act's coverage provisions; reduce overall health care costs; and address the unequal tax benefit of excluding from taxes the value of health insurance, which encourages businesses to continue to provide generous employer-based coverage.

Supporters of the new excise tax argue that these benefit-rich plans insulate workers from the high cost of care and encourage the overuse of care--such as unnecessary tests and hospital visits--that raise US health costs overall. However, the plans may be more costly and therefore subject to the new excise tax for reasons other than their generous benefits, including plan participants' health status or advanced age.

A 40% excise tax will be assessed, beginning in 2018, on the cost of coverage for health plans that exceed a certain annual limit ($10,200 for individual coverage and $27,500 for self and spouse or family coverage). Health insurance issuers and sponsors of self-funded group health plans must pay the tax of 40% of any dollar amount beyond the caps that is considered "excess" health spending.

Although the excise tax does not take effect for another four years, many employers are likely already scaling back their health benefit offerings or increasing workers' deductibles and copays to avoid paying the tax. Proponents argue that employers need a renewed focus on cost control, and that when consumers must pay a share of the costs, they will be less likely to overuse care.

For consumers, especially those in poor health or with chronic illnesses who rely on Cadillac plans to cover high annual medical expenses, the tax means that they'll have to pay much more for their health care. Critics of the tax say it unfairly "hollows out" and "slashes" health benefits.

It's not yet clear how widely the excise tax will be felt by both employers and consumers. This brief explains the tax, its current and projected effects, and what's next in the debate as the tax moves toward full implementation in 2018.

Currently nearly half of Americans get health insurance through their employers, with the tax exclusion for this benefit continuing to encourage businesses to offer coverage. By excluding the full value of employer-sponsored health insurance from individuals' taxable income, the federal government currently provides Americans with more than $250 billion each year in tax subsidies.

As the law now stands, beginning in 2018, both fully insured and self-funded employer health plans will be assessed the nonrefundable 40% excise tax on the dollar amount of any employee premiums that exceed annual limits of $10,200 for individual coverage and $27,500 for family coverage, excluding stand-alone dental and vision plans.

Additionally, the excise tax applies to the overall aggregate cost--the premium for the insured; the COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985) rate for the self-insured, which doesn't have premiums; and contributions to flexible spending accounts, health savings accounts, and health reimbursement accounts.

The excise tax applies to the insurer in cases where the plan is insured and to the employer where the plan is self-insured. For example, in either scenario, if the plan's total value exceeds the annual limit by $1,500, the issuer or employer would pay a 40% excise tax of $600. Total value is calculated by including both employer and employee premium contributions and any funds put into flexible spending and health savings accounts. According to the law, adjustments to the thresholds can be made for plans with a disproportionate share of women and older workers.

Adjustments to the thresholds for plans that have pre-Medicare retirees or have the majority of workers employed in high-risk jobs also increase by $1,650 for the individual plan and by $3,450 for the family plan (to $11,850 and $30,950, respectively). The limits are also linked to inflation and would increase as the US inflation rate rises. Specifically, in 2018 and 2019 they're indexed to the Consumer Price Index (CPI) plus 1 percentage point. In 2020 and beyond they're linked to CPI alone, which grows more slowly than medical spending.

The excise tax is expected to raise $32 billion over the 10-year period of 2010-19.

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