Both President Obama and Mitt Romney are interested in “closing loopholes” as part of broader tax reform, and both are famously reluctant to say exactly which loopholes they are talking about. The problem is that these “loopholes” are pretty popular and also fairly fundamental to the economy. By far the biggest loophole (or “tax expenditure” as official government documents term them) is “exclusion of employer contributions for medical insurance premiums and medical care.” That deduction costs the federal treasury $184B in 2012. The second biggest item is “deductibility of mortgage interest on owner-occupied homes,” at $99B, and then it drops off from there to $68B for 401(k) plans, $61B for step-up basis of capital gains at death and $51B for exclusion of imputed rental income.
Read through the list (Table 17-3 on p. 252 of this document) and you’ll understand why politicians are reluctant to say what they’re going to eliminate. The larger “loopholes” are mostly well-established, broad based and popular. Most people don’t think of deductibility of 401(k) plans as a loophole, for example, but rather a fundamental part of how they operate.
I’d love it if we could find bipartisan consensus on reducing (though not eliminating) deductibility for employer contributions for health insurance. I have at least a wee bit of optimism on this count. So-called private health insurance is heavily subsidized through the tax code. That means there’s less attention given to careful spending. All else being equal tax deductibility drives costs up. The Affordable Care Act actually addresses this issue through the so-called “Cadillac tax,” which will penalize the priciest plans. A major impact will fall on unionized employers, who tend to have the richest plans. One would think that Republicans could get behind the idea of limiting deductibility to the first $x dollars of per employee costs, and then making anything above that amount subject to taxation.
Going after deductibility of health insurance is tricky business, because it could lead employers to abandon their sponsorship of health care. If it’s done in a partial and gradual way, though, it could remove distortions in the health insurance market and reduct the deficit.