Approaching health law tax is not just a levy on luxury

The last major piece of the Affordable Care Act could raise costs for thrifty consumers as well as large corporations and union members when it takes effect in 2018.

The so-called Cadillac tax was meant to discourage extravagant coverage. Critics say it's a tax on essentials, not luxuries. It's getting attention now because employers plan ahead for major costs like healthcare.

With time, an increasing number of companies will be exposed to the tax, according to a recent study. The risk is that middle-class workers could see their job-based benefits diminished.

First to go might be the "flexible spending accounts" offered by many companies. The accounts allow employees to set aside money tax-free for annual insurance deductibles and out-of-pocket health costs. That money comes out of employees' paychecks, and they're not able to use it for other expenses. Savvy consumers see it as a way to stretch their healthcare dollars.

The catch is that under the law those employee contributions count toward the thresholds for triggering the tax.

There are other wrinkles: Companies in areas with high medical costs, such as San Francisco, are more likely to be exposed to the Cadillac tax than those in lower-cost areas like Los Angeles. Ditto for employers with unionized workers who won better benefits through bargaining.

Republicans in Congress and a sizable contingent of Democrats are calling for repealing the tax. Hillary Rodham Clinton, the front-runner Democratic presidential candidate, says she's concerned it will shift costs to workers. Since the tax doesn't take effect right away, it's an issue for the next president.

"As currently structured, I worry that it may create an incentive to substantially lower the value of the benefits package and shift more and more costs to consumers," Clinton said in response to a candidate questionnaire from the American Federation of Teachers.

The Cadillac tax has two purposes: to act as a brake on healthcare spending and to raise money for covering the uninsured.

The value of employer-sponsored health insurance is tax-free to workers and tax-deductible for companies. It amounts to an income tax break worth $206 billion this year, according to the president's budget. Many economists call that an indirect subsidy that encourages wasteful spending. They argue that if not the Cadillac tax, some other kind of limit is needed. Major Republican health overhaul plans have also proposed curbs.

A recent study from the nonpartisan Kaiser Family Foundation estimated that 26% of all employers would face the tax in at least one of their plans during its first year, 2018. Nearly half of larger companies would face the consequences of the tax that same year, because they tend to offer better benefits.

"It is a pretty broad-based tax that has a powerful effect on controlling the growth of premiums," said Larry Levitt, a co-author of the study. "The downside is workers may see an increase in their out-of-pocket costs."

Since the tax is indexed to general inflation, which rises more slowly than health insurance premiums, over time it would affect a growing share of health plans.

The Obama administration says such studies overstate the potential impact. The Treasury Department said in a statement that only "a small fraction of workers" would be affected. Regulations to implement the tax could soften some feared consequences, but proposed rules aren't expected until late this year or early next.

The Cadillac tax is 40% of the value of employer-sponsored plans that exceeds certain thresholds: $10,200 for individual coverage and $27,500 for family coverage. The tax is levied on insurers and plan administrators, who are expected to pass it back to employers. The 40% rate is well above the income tax rates that most workers face.

Joe Kra of the benefits consultancy Mercer said he believes many employees will be required to make fundamental changes in their health plans to mitigate the tax's impact. Measures such as ditching flexible spending accounts may not be enough. That would accelerate a shift to high-deductible plans that require workers to pay a bigger share of health costs before insurance kicks in.

Here are some other potential twists: