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Who will pay?

On Sept. 16, Sen. Max Baucus introduced the Senate Finance Committee's version of health care reform. It included a $6 billion fee on health insurance companies as well as similar fees on drug companies, clinical labs and medical device makers. That might lead some to believe that health corporations are going to pick up part of the tab. Not quite, as the burden of these fees will be borne by American families as part of the purchase price of health insurance.

The insurance fee applies to any U.S. health insurance provider, with the total fee apportioned among the providers based on relative market share. Thus, as any company sells more insurance, it will incur a greater market share, and thus a greater share of the $6 billion. That is, with each policy sold, the total tax liability rises, making the fee equivalent to an excise tax. As such, it is important to understand the difference between the statutory incidence of the excise tax - the insurance companies responsibility to remit the tax to the Treasury, and the economic incidence - the loss in real income as a result of the tax.

The imposition of a tax will upset the cost structure of the insurance companies, raising costs per policy and reducing net income. Some argue that the firms will "eat the tax" and accept a reduction in net income. Perhaps, for a short time. But doing so shifts the burden to shareholders. Because insurance companies compete for investor dollars in competitive, global capital markets, shareholders will not accept a permanently lower return and still supply the equity capital necessary for insurers. (A similar logic also applies to not-for-profit insurers, who rely on retaining earnings as reserves to augment their capital base. Bearing the burden of the tax means lower access to these reserves and diminished capital.)

Insurers might seek to restructure their labor compensation to offset the cost and restore profitability. This would involve reducing compensation growth, squeezing hiring (or even layoffs), or both. But, again, these efforts will be constrained by the realities that they are an invitation for the workers, especially the best-skilled, to simply depart for greener pastures.

In short, there are sharp limits on the ability of firms to shift the effective burden of excise taxes onto either shareholders (capital) or employees (labor). Moreover, their ability to do so diminishes over time as capital and labor seek out better market opportunities.

The Congressional Budget Office and Joint Committee on Taxation revenue estimating conventions recognize these economic realities. Specifically, they apply a 25 percent "offset" to the estimated gross receipts of any excise tax. In terms of the discussion above, the convention recognizes the incentives to attempt to shift some of the burden of the tax in the form of lower dividends, capital gains and wages. To the extent this happens, receipts of income-based taxes will fall; hence the need for an offset to the gross receipts of the excise tax.

The most important aspect of the offset is that it is not 100 percent. That is, the nonpartisan, consensus-based revenue estimators have concluded that the vast majority of the burden of excise taxes will not be borne by shareholders or workers. Who, then, bears the burden? Consumers.

Insurers will have no way to absorb the economic burden of the tax, so they will be forced to build it into higher premiums. Some are skeptical and argue that consumers will simply be unwilling to accept a higher price. Evidence suggests that this is not true, but what would happen if consumers resisted? As firms accept a lower rate of return, they will be unable to attract capital. As they cut wages, their ability to compete will be impaired by the loss of skills. Firms that attempt to adjust entirely on the cost side will be unable to maintain competitive operations and will lose market share or even shut down. For health insurance markets as a whole, this reduces competition. The bottom line for consumers is the same: higher prices.

To gain a rough empirical feel of the $6 billion health insurance excise tax, I used publicly available data for the 15 health insurance companies. The entire fee is a substantial impact on the cost structure and profitability of the companies, as the $6 billion is nearly 60 percent of the net earnings. Of course, these firms will be allocated less than the full fee; assuming that they are only one-half still yields a significant impact.

What happens to consumers? The insurance fee will likely mean insurance premiums will rise quickly, along with those for pharmaceutical companies ($2.3 billion), medical device manufacturers ($4 billion), and clinical laboratories ($750 million). The upshot: American families will pay as much as $130 billion more in insurance premiums during the next 10 years.

Douglas Holtz-Eakin was director of the Congressional Budget Office from 2003 to 2005 and is author of the Manhattan Institute report "Forging a New Plan for Health Care: Principles and Priorities for Sustainable Reform."

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