U.S. Industry is in the Crosshairs of Bad Tax Policy

General Motors Chairman Rick Wagoner recently told the Economic Club of Chicago: "Our foreign domiciled competitors have just a fraction of these costs, because they have few, if any, U.S. retirees, and in their home countries, their governments cover a much greater portion of employee and retiree health care costs."

General Motors says that the $5.6 billion the company spends on health benefits adds $1,500 to the cost of each new car.

Some labor union officials are arguing that a national government-run health care system would allow GM and other U.S. companies to better compete globally because they wouldn't be saddled with the ball and chain of health costs.

But health costs won't go away; they would just be moved to a different ledger. If companies don't pay directly, they would pay indirectly through higher taxes on the company and on workers to finance a public health care system.

Wagoner demonstrated his free-market savvy when he called for a different approach by providing new incentives for people to become "better health care consumers." The disconnect between consumers, providers, and prices is a big reason that health costs rise much faster than other consumer prices year after year.

Harris Interactive recently did a study to find out how much consumers know about health costs. They guessed the price of a new Honda within $300, but they were off by more than $8,100 in estimating the cost of a four-day hospital stay. With consumers so disconnected from the costs of their health care consumption, it is no wonder that health care inflation continues to soar.

Attacking symptoms won't help without getting to the root cause of the problem for GM, Ford, and all other U.S. firms that are being suffocated by high health costs.

U.S. companies are in the crosshairs of a tax law gone bad, a provision that is as powerful as it is invisible. The way tax law treats health insurance is a relic of World War II price controls and has been the driving force behind our industrial-age health policy. The system worked fine in the heady times of American's industrial dominance for the past half-century, but its day is over. The country is moving toward individual empowerment and ownership of health insurance. But tax law fights this change.

Section 106 of the Internal Revenue Code provides a generous tax preference for the health insurance that employees receive through the workplace. It allows the part of compensation which employees receive in the form of health benefits to be excluded from workers' income and payroll taxes.

This keeps most workers from knowing how much of their compensation is going to finance their health coverage. And it encourages them to bargain for (non-taxed) health benefits over (taxable) cash wages in the mistaken belief that the company is paying for their benefits. Whether it's called cash wages or health care, it is all part of an employee's compensation package.

The tax preference for job-based health insurance is the single largest tax break allowed by law -- worth an estimated $200 billion this year -- and it creates distortions throughout the health sector. It hides from workers the true cost of their health care consumption -- leading to token fees for doctors' visits and prescription drugs. And because consumers they don't see the full cost, they demand more health benefits and more expensive health insurance.

The cost of an average job-based health plan in the U.S. now is $10,800 a year for a family, and fewer and fewer individuals and small businesses can afford to keep up. The result: Fewer workers have generous, job-based health insurance, and more and more workers go bare.

Nonetheless, workers have demanded more and more of this seemingly free or nearly free benefit, to the point that benefits alone added $40 to an hour's wages for General Motors' parts supplier Delphi Corp.

Negotiations over health costs between GM and the United Auto Workers had been stalled for months until Delphi's Chapter 11 bankruptcy filing last fall got the union's attention. The union finalized a breakthrough agreement that trims GM's health costs by $1 billion a year. Union agreements with other auto manufacturers soon followed, realizing that if they don't give something now, they may soon be negotiating with employers who are in bankruptcy.

President Bush's commission on tax reform last year recommended a much needed change to tax law last year that would build in structural cost containment: It proposed capping the amount of income that employees can shelter from taxes, allowing only a fixed dollar amount of health insurance to be tax exempt.

Commission member Timothy J. Muris, a professor at George Mason School of Law and former head of the Federal Trade Commission, said he thought a reasonable ceiling would be the current $11,000 cost of a family, job-based policy. The value of health benefits above that would be considered taxable income for the employee. Employers should continue to be able to deduct the full cost of health benefits as a legitimate cost of doing business since it is part of employee compensation.

General Motors' concerns are very real, and health costs which rise unabated are unsustainable. Capping the tax break for job-based health insurance would begin to put a lid on soaring health costs and ultimately help U.S. companies to be more competitive.

This policy change would give U.S. companies a powerful new tool to make benefit costs more visible to employees, giving employers a new tool to engage their workers as partners in staying under the cap and holding down health costs. This would be a big step to help soften demand for more and more expensive job-based insurance that is driving vital American manufacturers to the brink.

Then General Motors could again focus on being a car company rather than a (health) care company.

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Grace-Marie Turner is president of the Galen Institute, a non-profit research organization specializing in health policy. She is the editor of Empowering Health Care Consumers through Tax Reform.