Will the ACA Cadillac Tax Reduce Healthcare Costs?

The ACA's Cadillac tax is set to take effect in 2020. How will it impact health plans?
The ACA's Cadillac tax is set to take effect in 2020. But how will it impact health plans?. Car Culture, Inc./Creative RM/Getty Images

The Affordable Care Act was signed into law in 2010, and most of its provisions had been implemented by the beginning of 2016. But one aspect of the law dubbed the "Cadillac tax" won't take effect until 2020. The Cadillac tax was originally supposed to be implemented in 2018, but in December 2015, lawmakers passed an omnibus spending bill that included a two-year delay on the Cadillac tax.

When it's eventually implemented, the Cadillac tax will impose a 40 percent excise tax on the portion of employer-sponsored health insurance premiums above a specified dollar level (the revenue from the tax would be used to cover other ACA provisions, like the premium subsidies in the exchanges). The initial threshold above which the excise tax would apply was $10,200 in total annual premiums for a single individual in 2018 dollars, and $27,500 in annual premiums for family coverage. This includes both the premium that the employee pays, along with the employer's contribution to the premium.

So if your health insurance plan's annual premium was above those amounts, your employer would have to pay a 40 percent excise tax on the portion of the premium above those levels. Clearly, this incentivizes employers to take steps to keep total premiums below the level at which the Cadillac tax applies.

What's the Benefit of the Cadillac Tax?

The idea behind the Cadillac tax was to make very high-end health plans less attractive for employers, and thus less common. The concern was that when people have health plans that have very little cost-sharing and lots of "bells and whistles," they may be more likely to overutilize health care since the insurance plan—rather than the patient—is paying for all or nearly all of the cost.

And employer-sponsored health insurance has long been excluded from taxable income. So when we look at total compensation for employees—including wages in addition to health insurance and other benefits—there's an incentive for employers to provide a larger portion of the compensation in the form of health insurance benefits, rather than wages. Combined with the ever-increasing cost of healthcare, that incentive and the concerns about over-utilization led to the inclusion of the Cadillac tax in the ACA.

What About Inflation?

Since the Cadillac tax is now scheduled to start in 2020 instead of 2018, the premium threshold above which the tax will apply is expected to be $10,800 for single coverage, and $29,100 for family coverage, due to the inflationary indexing that applies to the Cadillac tax.

So in 2020, if a health plan had an annual premium of $11,500 for a single employee, the portion of the premium over $10,800 (in other words, $700) would be subject to the Cadillac tax. And while that tax would be assessed on the employer, economists generally agree that such costs are passed through to the health plan enrollees (via higher premiums, for example).

Starting in 2021, the premium threshold—above which the Cadillac tax applies—would increase by the same percentage as Consumer Price Index (CPI) growth each year.

The problem? Health care spending has been rising faster than the CPI for a long time. And while it's possible that could change in future years, the distinct possibility that it won't means that the Cadillac tax could eventually become a "Chevy tax," as average premiums rise faster than the premium threshold where the Cadillac tax kicks in.

While it's rare today to have a health insurance plan with an annual premium over $10,800 for a single person, or $29,100 for a family, it might NOT be rare to have a health plan that hits those amounts (increased by the CPI) in 2030 or 2035, if health insurance premiums continue to increase far faster than the CPI.

The result would be that an increasing number of plans would be subject to the excise tax each year, assuming premium growth continues to outpace overall inflation. And eventually, run-of-the-mill plans (as opposed to just high-end plans) would be impacted.

How the Cadillac Tax Will Affect Employee Benefits

The implementation of the tax is still a few years out, but the general consensus is the employers will want to avoid paying it, and will thus work to structure their health plans so that total annual premiums remain below the threshold where the Cadillac tax begins to apply.

The most obvious way of doing that is to increase the cost-sharing on the plan, via higher deductibles, copays, and out-of-pocket maximums (within the maximum out-of-pocket constraints required by the ACA). Of course, that would tackle the problem that the Cadillac tax was designed to solve, since the whole idea was to move away from plans that cover all or nearly all of an enrollee's health care costs, in an effort to ensure that people aren't overutilizing health care.

And while that would be a likely outcome, the problem is that when out-of-pocket costs increase, people tend to cut back not only on unnecessary healthcare but also on necessary health care. Over the long run, that can result in chronic conditions that aren't well-controlled, and health care costs that are higher than they would have been if the care hadn't been avoided due to costs.​

There's also a concern that some employers might have a health plan that isn't particularly "Cadillac" in nature (ie, its benefits aren't dramatically better than average), but that has higher-than-average premiums due to the claims history or the employer's industry.

The ACA's ban on using claims history or industry categories to set premiums only applies in the individual and small group markets; in the large group market, claims history and industry can still play a role in premiums. So while the Cadillac tax is aimed at reducing the number of plans that offer truly high-end coverage, the use of a metric that judges plan based on premiums alone could be flawed, in that some high-premium plans might have high premiums for reasons other than their benefit design.

There are also concerns that in states like Wyoming and Alaska, where health care—and thus, health insurance premiums—is more expensive than average, more plans would fall into the Cadillac tax net, despite providing relatively average benefits.

Will the Cadillac Tax Be Repealed?

Between now and 2020, it's possible that the Cadillac tax could be repealed. The tax generally has support from economists (including the President's Council of Economic Advisors). But employers, unions, consumers, and politicians—on both sides of the aisle—are generally opposed to it. 

The Democratic Party's 2016 platform calls for repealing the Cadillac tax, and the GOP has long called for the repeal of the tax—along with all or most of the rest of the ACA. Given the bipartisan opposition to the tax, there's a possibility that it will not survive long enough to be implemented in 2020. 

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