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The Indefensibility of U.S. Fringe Benefit Tax Laws

When people look back at our period in history, they will see a whole set of policies that are indefensible. Today, I am starting a series that attempts to identify policies that are unjustifiable. Some of these policies are very important, others are less consequential. But they all are problematic. Yet, we continue to pursue many of these policies, and relatively few people question them.

One indefensible policy involves superior tax treatment for employee fringe benefits, such as health insurance and retirement benefits, which operates to harm lower income people.

It is well known that our tax system treats people who have to purchase their own health insurance differently than it treats people who receive employer provided health insurance. If one’s employer provides health insurance, the employee need not pay tax on the value of the insurance, even though this is a valuable fringe benefit. By contrast, if one does not receive employer provided health insurance, then one has to take one’s wages, pay taxes on them, and then pay for the insurance from those wages. Thus, the employer provided health insurance is tax-free but the individually purchased health insurance is taxed. This is indefensible. It is both economically inefficient and treats people who work for small companies, which are much less likely to provide health insurance, worse than those who work for larger companies. Many of these people at the smaller companies earn less income.

While this pernicious subsidy for employer-provided health insurance is well known, it is hardly the only example of such a problem. Another example involves savings for retirement. If one works for an employer that has a 401k or 403b plan, then one is entitled to put aside from pretax dollars a significant amount of money each year. But if one’s employer does not have a retirement plan of this type (or one does not work) and one must use an IRA, the limit of how much one can save for retirement each year tax free is much lower. Again, there is no justification for this difference in treatment. And again it treats people who tend to earn less worse than those who earn more.

There are other employee fringe benefits that receive more favorable treatment, such as employer-provided meals and employer-provided life insurance. The same story holds.

These inefficient and unfair provisions are not only bad in themselves. They also have the effect of causing additional public support for social insurance programs. People need retirement plans, health insurance, and life insurance. Ultimately, the question is whether they get these services from private action or from social insurance. By rendering private insurance and private action for many in the middle and lower classes less desirable, these provisions operate to increase the support for social insurance.

Reader Discussion

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on January 08, 2019 at 14:12:33 pm

Then again, why are 80% of my Social Security benefits taxed while some one with no or lesser income is provided SS monies "tax free."

Also, it is rather questionable that tax free treatment of fringe benefits harms the MIDDLE Class as most in the middle class receive health insurance from their employer. It is the independent contractors, small business types and, yes, small independent legal practices that suffer. Indeed, following the disaster known as O-Care such small practices were made to endure a "double-whammy" - taxation AND very drastic increases in the cost of the health insurance coverage purchased for their families.

Something or another is ALWAYS indefensible.

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gabe
on January 09, 2019 at 13:37:46 pm

All of this is yesterday's news, and the writer ought at least to show some consistency. Arguing that a lower IRA contribution limit is inherently unfair to people who don't have much to contribute in the first place suggests the writer is just regurgitating libertarian doctrinal articles without giving them any of his own thought.

Also, all of these tax provisions were put in place during an era in which far more people were actually long-term employed by long-term employers. A great many people used to benefit from these provisions. Of course wealthy people always benefit by a greater dollar number from tax exemptions than less wealthy people. That is purely a function of the arithmetic of progressive taxation. Adherence to the marginal utility logic of progressive taxation necessarily means that the marginal benefits to the wealthy and the less wealthy of a tax exemption are equal.

But in an era of diminishing long-term employment by long-term employers, the problem posed by these tax anachronisms is rather far down the list of problems. Besides, the reason that repeated, decades-old calls for radical simplification of the tax code have gone unheeded is that such a reform would render Congress mostly superfluous.

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QET
on January 29, 2019 at 13:32:44 pm

I mostly concur, especially as to retirement plans. However, there is a complicating factor on health insurance.
Some (Many? IDK) companies with lots of employees buy what is, in effect, No Insurance insurance. They hire, eg, Aetna as the plan administrator but pay the actual approved health care expenses out of their own pocket. Over time and many employees, this is not a larger financial risk for the company than it would have been for Aetna (Aetna would have guessed at next years health bills and tacked on a profit margin to calculate the premium.)

I imagine Aetna offers the same service to small firms, but with a small number of employees it looks like a reverse lottery - one employee at a firm of twenty could get cancer or heart disease and bankrupt the place. Citibank can take for granted that some number of employees will get cancer and heart disease each year.

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Tom Maguire
on January 29, 2019 at 14:11:06 pm

Arguing that a lower IRA contribution limit is inherently unfair to people who don’t have much to contribute in the first place suggests the writer is just regurgitating libertarian doctrinal articles without giving them any of his own thought.

Nonsense. Lots of people who work for small businesses that don't offer a 401(K) and lots of early retirees would love to put $19K into a 401(k)-type investment vehicle but are limited to the piddly IRA contribution limits, which leads me to think that the commenter is just regurgitating leftist doctrinal talking points without giving them any of his/her own thought.

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Roader
on January 29, 2019 at 14:25:01 pm

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on January 29, 2019 at 14:41:05 pm

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on January 29, 2019 at 19:43:12 pm

I would love to see the Democrats tax fringe benefits. It would be the total destruction of party and that would be a common good.

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Image of Rick Caird
Rick Caird
on January 29, 2019 at 20:59:33 pm

The inequities of the tax treatment of health insurance premiums may be well known to business executives and health care policy analysts, but they are not well known to the general public, especially those who benefit through employer plans. They don't particularly want to know and business executives and health care policy analysts don't particularly want to explain it to them, for fear of upsetting the apple cart. Honest discussion of the subject is impossible because lives are at stake and nobody trusts anybody—for good reason.

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Image of Robert Dolan
Robert Dolan
on January 30, 2019 at 00:01:03 am

Yes. I noticed this years ago, when FLEX benefits started rolling out. If I worked for the right people, I could send some tax free money in that direction. If I didn't work for the right people, I couldn't set aside money for medical expenses, tax free. Yup.

Of course, part of our health care mess stems for FDR and WWII salary freeze. Benefits weren't frozen, and so health care became a benefit, tied to your employment. That model worked for a while, and now it doesn't, and we don't have a good way to change things. Prices became inflated in that model, and so that makes changing it very difficult.

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Milwaukee
on February 05, 2019 at 05:47:10 am

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on February 15, 2019 at 09:02:12 am

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Law & Liberty welcomes civil and lively discussion of its articles. Abusive comments will not be tolerated. We reserve the right to delete comments - or ban users - without notification or explanation.