A Tax Increase That Even Republicans Might Love

Jan. 26 (Bloomberg) — You know something is up when the Republicans and Democrats trade positions.

That's what is happening this season when it comes to a certain proposal to increase taxes on business and the rich. Democrats, the party of economic redistribution, detest the proposal — Charles Rangel, the new Democratic chairman of the House Ways and Means Committee, labels it "dangerous."

As for the Republicans, those old anti-tax warriors, they are going around moaning about how tragic it is that President Bush lacked the guts to put through this particular increase two years ago, when he had the votes to do so.

So what is the mystery tax? It is a levy on employer-provided health benefits that cost more than $15,000, a proposal included in Bush's State of the Union address.

Under the plan, employers would lose the ability to deduct the cost of the health-insurance policies they buy for workers. What's more, that cost would be counted as income on the worker's return. The anti-tax team accepts this because of what it brings with it: a standard deduction of $15,000 for every household. This means an effective tax cut for many families because their annual premiums add up to less than $15,000.

But the big change here isn't in the pennies and dimes. It is in the way the plan lodges responsibility for a family's health budget with the family, instead of employers. This isn't merely a tax shift but also a cultural shift, Republicans say. It would make Americans feel stronger and more economically secure.

Long Overdue

And they are right. In fact, the move is long overdue. The old system of employers providing health care is as much a result of historical accident as of coherent policy. Back in the 1930s, Congress and President Franklin Roosevelt created Social Security over corporate protests. A national system of payment for health care seemed next. (In 1945 Harry Truman would go around talking about "the right to adequate medical care.")

Terrified employer raced to preempt FDR and Truman by proving they could handle health themselves. They contracted with Blue Cross and Blue Shield to provide benefits for employee pools. The tax treatment came last — in fact no one knew for a while whether companies really could claim the insurance deduction.

But World War II made the new arrangement seem doubly logical. Congress imposed an "excess" profits tax of as much as 90 percent and froze wages. Paying for health insurance was a way to reduce tax bills and keep workers, who were suddenly scarce. Unions were pleased. By 1945, 32 million Americans were in health-insurance programs, many sponsored by companies, up from 12 million to 13 million just five years before.

Organization Man

Though such fringe benefits quickly came to feel as American as a Ford in the driveway, the arrangement affected our culture in ways that were not all positive. It helped give rise to the Organization Man of the 1950s, a fellow dependent on his employer to the point of caricature. Corporate health plans also smothered incentives to economize. Having three parties responsible for health-cost decisions meant that no one was. Needless to say, innovations from magnetic-resonance imaging devices to the heart stent — you name it — only expanded spending.

Fast forward to today and the accidental health insurance exclusion has morphed into a giant revenue drain. In 2007, the federal government will forgo about $150 billion in tax revenue by way of this break. That figure is higher than the cost of either of two other such deductions, one for home-mortgage interest and the one for state and local taxes. It is something like paying for the Iraq war each year.

Easing the Fear

But what about now? Rangel argues that society is shifting too much risk on the individual. Those of us who have known the sickening fear of losing a job and its health insurance tend to side with the Ways and Means chairman.

The change proposed might actually lessen that fear. Under this plan, your health deduction stays with you, even if the boss decides to live up to your nightmares and fire you. You don't have to persuade a new insurance company to pay for your daughter's preexisting condition because you can stay with your old insurance.

This independence allows employees to make an honest assessment of whether a job is really worth keeping. You will always be free of Cobra, the government program that allows you to keep your old company's insurance — but just for a while, and only under certain conditions.

The system ought to please middle- and lower-wage earners, since the deduction will reduce the base wage upon which both their income tax and social security are levied.

"This is a real first," says Michael Tanner, director of health and welfare studies at the Cato Institute. "Never before have deductions applied to Social Security taxes, still the highest tax for 80 percent of taxpayers."

Worth Considering

This should be a big change for those at jobs that offer no insurance. Higher earners likewise may find the break worth having, especially if legislators could write the law so that the standard deduction is safe from the alternative minimum tax.

But if the Democratic leadership is already rejecting the Bush idea, is it still worth thinking about? The answer is yes. Parties come up with some of their best ideas when they are down — ideas that tend to become law five or 10 years later.

Several other Bush proposals have been fakes — programs that called themselves free market but actually extend the role of government, such as the Medicare Part D prescription-drug plan.

The standard-deduction plan, by contrast, truly is free market and anti-Washington. Though it may have come at the wrong time, this increase is one all can endorse — even the tax warriors.

(Amity Shlaes, a visiting senior fellow at the Council on Foreign Relations, is a Bloomberg News columnist. The views expressed here are her own.)

© Copyright 2007 Bloomberg

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