Health Plans Could Aid, Hinder Efforts To Fund Social Security

By Jed Graham
Yahoo News
August 17, 2009

While a health care overhaul takes precedence, the Obama administration will eventually tackle the Social Security issue, top White House economic adviser Lawrence Summers said last week.

In reality, Social Security is on the table right now, though few seem to recognize it.

The demographics of an aging population and slow-growing work force are the primary forces behind Social Security's coming shortfalls, but spiraling health care costs are no small factor. There will be fewer workers per retiree, and a bigger portion of total compensation will be devoted to tax-free health care benefits.

Social Security's actuaries project that untaxed compensation, primarily health coverage, will increase from 19% of total pay to 31% over the next 75 years.

Helping Or Hurting?

Changing this trajectory -- by changing the tax treatment of health care -- could have a major impact on Social Security's finances. And this idea is central to the debate over paying for near-universal medical coverage.

Oregon Democratic Sen. Ron Wyden's Healthy Americans Act -- whose 13 co-sponsors include five Republicans -- would end the tax-free status of employer coverage and convert the savings into a tax credit to make insurance more broadly affordable.

Over the next decade, ending the tax exclusion for employer health coverage would raise $3.5 trillion, the Urban-Brookings Tax Policy Center estimates. That includes $1.3 trillion in payroll taxes, of which nearly 80% would be due to Social Security.

Such a dramatic tax change -- if the extra payroll taxes went to Social Security -- would erase roughly 65% of the program's official 75-year shortfall, or 45% of the broad unfunded liability that includes the $2.4 trillion trust fund.

This improvement would come despite the fact that Social Security would owe benefits on the extra payroll taxes.

Whether this improvement is real or illusory depends on whether the government devotes much -- or all -- of this revenue windfall to its new health care entitlement.

"Whatever lever you're using to pay for health care is a lever that you've lost for the subsequent major budget issues, Social Security included," said Donald Marron, who served on President Bush's Council of Economic Advisers and later as acting director at the Congressional Budget Office.

The Senate Finance Committee's effort to craft a bipartisan bill also targets the tax exclusion for employer-provided care -- in a roundabout way. Rather than hit workers directly, the tax would fall on insurers offering high-cost policies, perhaps over $21,000 for a family policy.

This approach wouldn't apply payroll taxes on high-cost policies, but it could help Social Security indirectly -- if it succeeds in holding down health insurance premiums and slows the growth in nontaxable compensation.

The specifics of the Senate Finance plan have yet to be released, but it might raise $180 billion over a decade, or 5% of the revenues that could come from ending the tax exclusion.

Political Roadblocks

Earlier, the finance panel set its sights on raising $320 billion by capping the level of tax-free employer health coverage. But lawmakers went back to the drawing board after President Obama made known his objection.

"The president is not helping us," Senate Finance Committee Chairman Max Baucus told reporters in July. "He does not want the exclusion. That's making it difficult" to pay for universal coverage.

Political hurdles to limiting the tax exclusion include staunch union opposition and Obama's pledge not to raise taxes on households earning less than $250,000.

Yet curbing the growth in tax-free employer health expenditures looks like the only route to bipartisan work on a medical overhaul.

Policy analysts on both sides of the political spectrum argue that the tax preference for spending on health care greases the skids for fast-growing costs because individuals pay relatively little out of pocket.

Curbing the tax exclusion could make them more discriminating consumers of health care and hold down costs.

Compared to increasing marginal tax rates, altering the exclusion offers the possibility of "achieving policy objectives while having a limited interference with economic growth," said Joshua Gordon, policy director at the budget watchdog Concord Coalition.

Congress also needs a funding source that keeps up with health costs that tend to grow faster than the economy, Gordon said. The tax exclusion fits the bill.

A further reason for looking at the exclusion is that it might make Social Security's challenges more manageable -- and limit the need for middle-class tax hikes to restore solvency.

Ryan's Song

Only a single Social Security overhaul plan has involved the tax exclusion.

That plan, introduced in 2008 by Rep. Paul Ryan, R-Wis., was part of his approach to reforming health care, reining in entitlement spending and simplifying -- and cutting -- taxes.

Ryan's approach, largely applauded by small-government conservatives and derided by liberals, won praise from tax experts for its comprehensiveness -- if not its prescriptions.

"It is an agenda that aims to add up ... not just a package of unfunded promises," wrote Tax Policy Center researcher Howard Gleckman. "By linking tax, spending, health and retirement policy into a single package, Ryan gives us a chance to see how all these pieces fit together."

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