Is the Excise Tax Good Policy?

January 21, 2010

Now that the Democrats have lost control of the 60th vote in the Senate, the only option for immediate legislative action on healthcare is for the House to adopt the bill already passed by the Senate. I join the chorus of those who have called for the House to buck up and pass the bill now and revise it later through reconciliation. But House Speaker Nancy Pelosi has now announced that she does not “see the votes” for adopting the Senate bill without modifications.

Most of the discussion of whether the House should pass the Senate bill has been about political strategy. But the House’s number one complaint about the Senate bill has been the excise tax on high-cost health insurance plans, largely because of labor unions’ opposition to the policy. The recent deal struck between the White House and labor leaders softened that opposition and introduced some sensible refinements to the tax, but that deal is moot if no further action is possible in the Senate.

So, leaving the politics aside, is the excise tax good policy?

The balance of opinion in my blogroll seems to be for it, more or less. But there are a few reasons I just haven’t been able to close the deal. (Though again, just to be clear, I very much believe the House should pass the Senate bill and work to improve the details later.)

First, I have a hard time believing it will be a real game-changer on cost control. And if it doesn’t come through on cost control, then it doesn’t amount to much more than a convoluted device for raising revenue.

Second, I think there’s a legitimate concern that, to the extent the excise does rein in spending, it will do so by shunting people into plans with high deductibles and co-pays, which might result in patients avoiding needed visits to the doctor—instead of doctors avoiding unneeded tests and procedures.

Cost Control

The theory behind the excise tax, says Jonathan Gruber, is this:

It would reduce the incentives for employers to provide excessively generous insurance, leading to more cost-conscious use of health care and, ultimately, lower spending. In other words, it “bends the curve.”

This biggest question mark for me is the mechanism by which the tax is supposed to slow the growth of health spending. Health policy analysts broadly agree that the root cause of our healthcare cost crisis lies in structural defects in the way care is delivered and paid for. Fee-for-service medicine incentivizes inefficiency and waste, as Atul Gawande famously illustrated. This suggests that reform must reach the payer-provider relationship if it is to have any hope of slowing the growth of spending.

But the excise tax targets the other side of the system: the payer-consumer (or insurer-insured) relationship. So how is this supposed to translate into reform on the payment side? Austin Frakt:

[I]n theory anything that is taxed should experience a lower demand. Therefore, one would expect that individuals and employers will seek lower premium plans to avoid the tax. In doing so they have to give up something and it can only be benefits or show up in the form of increased cost sharing. That could induce lower utilization and therefore lower costs overall. Perhaps insurers will try harder to create plans with lower premiums (to woo employers). One way they could do so is by negotiating lower rates with providers if they can. Economic theory would suggest they already get the lowest possible rates given market power. So I don’t know that there is much to gain there.

Tim Jost drives the point home:

The excise tax would not give insurers more bargaining power in dealing with hospitals, doctors and drug companies. It would not create new innovations in delivery systems. It would not generate credible evidence to “manage” care. It would not do anything but force insurers to offer cheaper plans to whoever had unhealthy enough employees to qualify for the tax.

My takeaway from all this is that the tax may trim some excess in the form of luxury benefits (more on that below), which could indeed reduce costs. But, because it doesn’t reach the underlying problem of provider incentives, it is highly doubtful that it will succeed in reducing the rate of growth of costs. It targets the wrong side of the equation. Which brings me to my second area of concern about the policy: its fairness.

Fairness

At least three separate fairness concerns have been raised repeatedly by critics.

First, the excise tax has been said to unfairly burden people on plans in high-cost regions of the country and plans that are expensive as a result of the age or gender profile of the risk pool. These concerns were to be addressed (in bill-merger negotiations) through special adjustments to the threshold at which the tax kicks in.1 But without the ability to pass a modified bill in the Senate, this issue remains a serious one.

Second, a common concern, recently articulated by Maggie Mahar, is that employers will pocket the savings that result from switching to cheaper plans, rather than passing the savings on to their employees as increased wages. Economists tend to answer this concern by pointing to the tradeoff between benefits and wages. Basically, it is axiomatic among experts that every dollar of compensation you receive in benefits is a dollar you give up in wages. As Austin Frakt has put it, “Workers pay the premiums even if employers appear to.”

I’m not sure the economists’ answer will satisfy critics of the excise tax, though. I think the critics’ point is really that employers will try to game the transition, exploiting the opportunity to lower employees’ overall compensation. But even if some employers do engage in mischief, the labor market will eventually force the numbers into line. It’s possible I’m too trusting of the experts here. But my intuition is that, if employers are able to get away with undercompensating their employees, they’re probably already doing it. And if they are, that’s a problem, but it’s not a problem created by the excise tax.

The third fairness concern is the one that troubles me most. There are only two ways to get people onto lower-priced plans without lowering the actual costs of care: (A) to cut plan benefits, or (B) to offer plans with higher out-of-pocket costs (deductibles and co-pays).

(A) would be smart policy if benefits were extravagant. And maybe they are sometimes. But a recent study in Health Affairs found only 3.7% of cost variation between high-cost and low-cost plans can be ascribed to benefit design. That suggests that there is not a lot of fat to trim from Cadillac plans without cutting into core benefits.

The trouble with (B), and arguably with the excise tax in general, is that it puts the burden of reining in spending on the consumer and seems as likely to prevent sick people from getting care as anything else. The excise tax cuts spending by squeezing utilization on the consumer side.2 But it is the providers who are making all the important utilization decisions. We just do what we’re told. Doctor’s orders!

Maggie Mahar argues:

75 percent of our health care dollars are spent on patients suffering from serious chronic diseases such as cancer, heart disease, stroke, and chronic obstructive pulmonary disease.
* * *
[C]hronically ill patients don’t make the decisions on big ticket items such as surgery, hospitalization, a battery of expensive tests, or a drug that costs $50,000 a year. Doctors and hospitals tell them what they must have to survive. Co-pays and deductibles will not make these patients more “cost-conscious.”  Cost-sharing will only give a distraught stroke victim another reason to worry.

Patients do make small decisions. Should  I visit the doctor? Should I have my blood pressure checked?  Should I try a smoking cessation clinic? And here, research shows, that if they face a co-pay, there is a 50/50 chance that they will make the wrong decision, foregoing needed care.

However, Mahar does acknowledge that the Senate bill (§ 2713(a)) prohibits co-pays on preventive care recommended by the US Preventive Services Task Force. That presumably reduces the scope of this concern. But it still seems a legitimate one.

Conclusion

Supporters of the excise tax are apt to say reasonable things like this, from Krugman:

[W]e really don’t know what it will take to rein in health costs, but that’s a reason to try every plausible idea that experts have proposed. Limiting tax deductibility is definitely one of those ideas.

I think that is the right attitude to have. I also think it’s important to remember that there will be lots of time and opportunity to tinker with the details later, and for now the most urgent need is to pass a bill so that there will be details to tinker with. Austin Frakt puts the excise tax in perspective (and shows that I could have saved myself the trouble of writing this post by quoting him extensively):

On the whole, the tax is quite a ways removed from the real problems, which are over-utilization of low efficacy care and high unit prices. Were I to design a tax I’d want to target those things.

The Cadillac tax is blunt but it raises revenue while avoiding the politically difficult fight with providers. …. I’m willing to accept putting off the real tussle over health care costs for now just so we can achieve some important insurance market reforms and set up some structures (do some pilots and demos) to prepare for that fight later, which is what current legislation would do. But someday, and quite soon–but not this year–we’ll have to return to the cost issue in earnest.

The Cadillac tax is a stop gap measure, but nobody should fool themselves into thinking it will solve the real cost problem.

  1. The Senate bill does provide adjustments for plans in 17 high-cost states. [↩]
  2. A classic study by RAND known as the Health Insurance Experiment (HIE), summarized here, showed that cost sharing requirements can reduce utilization without affecting the quality of care. But doubts about the applicability of the HIE, articulated here by Tim Jost and Joseph White, also seem reasonable. [↩]
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