One of many taxes Democrats have suggested levying to fund an expansion of health care entitlements is a repeal of the health care benefits tax exclusion. Sen. Max Baucus, chairman of the Senate Finance Committee and a key player in the current reform cycle called this option “perhaps the best way to raise money for an overhaul of the health care system”. Though President Obama savaged Sen. John McCain for proposing to repeal the exclusion before the 2008 elections, his administration now appears open to similar plans.

Employees currently pay no taxes on their health care benefits. This problematic quirk forces Americans to buy insurance through their employer or pay a tax penalty on individually purchased insurance policies. Employers tend to offer a highly constricted set of plans. Biasing the market toward employer coverage restricts individual choice and hides the true cost of insurance.
Leveling the playing field between the employer and individual insurance markets would be a good thing – if “leveling” merely meant balancing a repeal of the health care tax exclusion with a flat tax cut elsewhere.  But Democrats are only offering to raise taxes, in violation of Obama’s “pledge”.  Efficiency gained within the health care market will be squandered in the economy at large. Higher tax rates will reduce incentives to work, and new government spending will misallocate resources.
Nor are Democrats willing to allow individual insurance markets to benefit from reform. They favor a cap rather than a repeal of the tax exclusion – which would leave the market only slightly less skewed toward employer coverage. And many Democrats also propose employer mandates that would cement the current employer based system.
Health reformers dreaming of a more vigorous individual insurance markets should look for other ways to achieve their goal. Even if the roadblocks created by Democratic proposals were overcome, taxing health care benefits would remain broadly unpopular. Opponents range from staunch Democrat loyalists like the International Brotherhood of Teamsters to the business community – which would have to pay higher taxes on wages.
If free-market reformers rally behind a repeal of the exclusion, they risk hanging themselves with a huge new tax for no gain. Instead, they should work to extend tax exempt status to the individual insurance market. This could be achieved by expanding Health Savings Accounts (HSAs) as Cato’s Michael Cannon proposes. Alternatively, Sen. Jim DeMint’s Health Care Freedom Plan would create tax credits for individuals and families purchasing insurance outside their employers. These plans allow a more transparent, competitive individual insurance market to thrive without threatening vested interests or supplying funds for conflicting proposals. Sincere reformers should rally around these simple, effective measures.