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Taxing Health Benefits: Liberals Should Like This Idea

Henry J. Aaron is a senior fellow in economic studies at the Brookings Institution and one of the nation's most well-respected experts on budgets, taxes, health care, and retirement programs. We asked for his thoughts about proposals to finance health care reform by limitiing or eliminating the existing tax exclusion for group medical benefits. Here they are:

Capping, or in some other way limiting, the exclusion from income and payroll tax of employer financed health insurance is clearly a good idea from the standpoint of reducing the incentive for open-ended (which is to say, excessive) health insurance.  But some would suggest it's a bad idea, because it might raise taxes on some people whose taxes we believe should not be raised. 

You hear the same argument about cigarette taxes: cigarettes kill and they mostly kill the mostly lower-educated, lower-income people who disproportionately smoke and who would disproportionately benefit to the extent that taxes discourage smoking and thereby save lives. But, hey, cigarette taxes are regressive, so supporting them is somehow illiberal.

I have a term for this kind of thinking. I call it "distributional correctness." 

Look, not every element of policy has to be progressive.  What counts is the overall system and its effects.  A regressive tax measure (and capping the exclusion of employer financed health insurance would not be regressive) that makes possible the extension of coverage to the millions of disproportionately low-income un- and under-insured is a good idea. And it is a liberal combination.

On grounds of distributional correctness, the value-added tax is a bad idea. Right?  Well, maybe not.  Would you rather be low income in, say, France or Germany or Holland, with their regressive value-added taxes? Or in the United States with its (overall) much more progressive federal tax system? 

It's not a close call. You should choose to be poor in any of those three other countries because those value-added taxes pay for health coverage, family allowances (in France), better social security retirement and disability systems, unemployment insurance that covers almost all of the unemployed rather than the fraction we cover, and so on.

Most redistribution occurs through the expenditure side of the budget, not the tax system.  And that generalization holds for a cap on the tax exclusion of employer sponsored health insurance that went to pay for covering the uninsured.  Would it be better to replace the exclusion with an income-tested, refundable tax credit, linked to reform of the individual insurance market?  Sure it would.  But we have been hung up doing nothing on health insurance reform for so long in no small measure because everyone's second choice for health reform--including that of liberals or, if you prefer the newer adjective, progressives--when they can't get their first choice, is doing nothing. 

Henry Aaron