ESHI Reform Policy Memo

Subject: Reforming the Tax Exemption for Employer-Sponsored Health Insurance to Lower Health Care Costs for American Families

Summary:

This memorandum proposes a reform of the federal tax exclusion for employer sponsored health insurance. While this exclusion was originally intended to support employees, the exclusion has become a regressive exemption that drives up health care costs and weakens wage growth for working families. The exclusion also contributes to moral hazard in the health care market by encouraging employers to provide plans with high premiums and low deductibles. This memo recommends removing the exclusion and introducing a Portable Care Credit (PCC); a portable, income-adjusted tax credit that individuals can use to purchase coverage of their choice. This reform supports lowering costs, increasing take-home pay, and restoring choice for working Americans. 

Background: 

The ESHI exclusion was first introduced in 1943 by an IRS administrative ruling and was later codified into law in 1954 by Congress. It was the third largest tax expenditure in the FY24 federal budget, costing $213 billion dollars. Because the exemption applies only to employer-provided coverage it disproportionately benefits higher-income workers with better benefits while limiting assistance to lower-income Americans, the self-employed and those in non-traditional work arrangements such as “gig jobs”. The exclusion also hides cost transparency for health care by shifting worker compensation from wages to untaxed insurance benefits. As premiums rise, workers experience stagnated wage growth while employers absorb higher benefit costs. This depresses take-home pay and incentivizes “job lock” as workers often stay in jobs to maintain coverage.

Modern Problems:

When first introduced, the exclusion expanded coverage in earlier periods, as workers relied on stable benefits and were more likely to stay in a single job for the majority of their working career. Today, the policy is counterproductive as higher income workers receive larger tax benefits, compensation growth is diverted to health insurance premiums, and employees face “benefit buy down”, or higher costs for less benefits. 

Recommendation: The Portable Care Credit 

The PCC would replace the exclusion with a refundable, income-adjusted tax credit that individuals use to shop for products in the private insurance market. This would allow for coverage to follow workers, ensure fairness and empower working class Americans to access products that work for their budget and their specific family needs.  

Conclusion:

Reforming the tax exclusion into a portable tax credit would provide for a fiscally responsible, free market driven solution to combat rising health costs, which is one of the top problems facing most Americans today. This proposal also aligns with pro-worker economic objectives as it helps working families mitigate one of the costliest areas of their day to day living expenses. 

Reference: 

“Tax Expenditures and the Budget, Explained | Bipartisan Policy Center.” Bipartisanpolicy.org, 2024, bipartisanpolicy.org/explainer/tax-expenditures-and-the-budget-explained/.