February 3, 2015

The Impact of Taxing Health Premiums

Excluding the health insurance premiums paid by employers and employees from workers’ taxable earnings is the federal government’s largest single tax expenditure, amounting to some $250 billion a year in lost revenue.

Eliminating the exclusions – as some in Washington have proposed – would sharply increase how much is taken out of workers’ paychecks for payroll taxes and for income taxes. But any such proposal would also put more money in their pockets when they retire by increasing the earnings base on which their Social Security benefits are calculated.

Urban Institute researchers Karen Smith and Eric Toder recently estimated the policy’s impact on workers’ taxes and benefits and found that it varied widely for different income groups and among people born in five different decades, the 1950s through the 1990s.

Their analysis took into account the myriad idiosyncrasies of the U.S. tax code, including a regressive payroll tax, a progressive income tax, Earned Income Tax Credits paid to the lowest-wage workers, and the cap on payroll taxes for the highest earners.  To evaluate the proposals’ impact, the researchers added the premium amounts paid by both the employer and employee to workers’ taxable incomes – just as the deficit reduction proposals would do.

The resulting tax bite would be largest for the middle class.  That’s because middle-income workers are more likely to have employer-provided health insurance than lower-income workers, and their insurance premiums are a larger share of their income than they are for higher-income groups.  Under the proposal, middle-income workers’ federal income and payroll taxes would rise by an amount equal to 3.5 percent of their lifetime earnings. …Learn More