Employer health care pl ans benefit from the ability to exclude the value of the insurance paid by the employer from employee income and payroll taxes. This provision, known as the employer-sponsored insurance (ESI) tax exclusion, has been viewed by some as encouraging too much spending on insurance and therefore on health care. During consideration of the Patient Protection and Affordable Care Act (ACA; P.L. 111-148 , as amended) proposals to limit the amount of benefit excluded from tax under this provision were addressed. The final bill did not limit the amount of benefits employees can exclude from income and payroll taxes, but it did include a related provision that is popularly termed the Cadillac tax . This provision imposes an excise tax on the cost of ESI coverage that is in excess of a predetermined threshold. The original Cadillac tax differed from other typical excise taxes in two ways: (1) it was imposed on amounts in excess of a dollar floor and (2) it was not deductible from the income tax. Deductibility was restored by the Consolidated Appropriations Act, 2016 ( P.L. 114-113 ). It is imposed on the coverage provider, either a third-party insurer or, in the case of self-financed plans, the plan administrator (which may be the employer). The Cadillac tax is imposed at a rate of 40%. This tax rate is applied on a tax-exclusive basis , as is generally the case with excise tax rates. That is, like a sales tax, it applies to the price or cost excluding the tax. By contrast, the tax rate relevant to an income tax exclusion is on a tax-inclusive basis : it is applied to a base that includes the tax. A 40% tax applied on a tax-exclusive basis is equivalent to a 28.57% rate (0.4/1.4) applied on a tax-inclusive basis. That is, if the tax base is $100 dollars, the tax will add $40. The rate on a tax-inclusive basis is the tax ($40) divided by the base plus the tax ($140). As noted, the Cadillac tax was originally nondeductible from the insurer's gross income (or the employer's gross income, in cases where the employer self-insures). This treatment is unlike other excise taxes. (See the Appendix for further discussion.) Deductibility was allowed in the Consolidated Appropriations Act, 2016. (See the Appendix for further discussion of the effect of this change.) The Cadillac tax was originally to take effect in 2018. The Consolidated Appropriations Act delayed the effective date to 2020. The tax is projected to be imposed on plans that cost more than $10,800 for single health plans and $29,100 for non-single (e.g., family) plans. The exempt amount is indexed for inflation, and, because health costs tend to grow faster than inflation, the share of premiums covered by the tax and the revenue collected is expected to grow. (The threshold was indexed for health care costs for 2019, however.) Unlike a limit on the exclusion of benefits, which would increase the taxable income of the employee, this tax is imposed on the coverage provider, often the health insurer. Like the proposals to amend the employer health care exclusion that were discussed before the tax was adopted, however, the Cadillac tax is aimed not only at providing financial support for the costs of the ACA (such as premium subsidies to help lower-income individuals purchase health insurance) but also at reducing expenditures on health care. This report examines several issues. It evaluates the potential of the Cadillac tax to affect health insurance coverage and, therefore, the health market. It also examines the expected incidence (burden) of the tax—that is, which group will pay the price of the tax. In addition, the report discusses the efficiency of the tax in the context of administrative cost. The health care sector contains many sources of market failure, which create economic inefficiencies. The inefficiency that is most directly related to the Cadillac tax is the moral-hazard issue that results from having health insurance. In general, insured individuals spend more on medical care than they would without insurance. More demand for medical care raises the price of medical care, and it could reduce incentives for individuals to take responsibility for their health status (to the extent that they can). Incentives that encourage insurance consumption, such as the unlimited ESI tax exclusion, can increase these inefficiencies in the market for medical care. The Cadillac tax is intended in part to reduce this source of inefficiency. Although some employers and employees may choose to retain high-cost plans, others may scale back to avoid the tax. For employees in the latter group, the cost of health care increases, for example, through higher co-payments and larger deductibles. Figure 1 illustrates the effects of the Cadillac tax on the national market for medical care using a supply and demand framework. In this diagram, the effects of insurance and the Cadillac tax are depicted as the share of cost, s, paid by insurance. Therefore, the cost to the consumer is P(1-s), where P is the market price of the health care. Note also that the points on the graph do not reflect magnitudes but are illustrative, as the effect of the Cadillac tax is small relative to the effect of insurance. The points on the graph can be defined as follows: P* and Q* are the price and quantity in a market without insurance, where consumers face the full costs of their medical care decisions. P i and Q i are the price and quantity in a market with insurance and subsidies (such as the ESI tax exclusion), where individual consumers pay a portion of their medical costs out of pocket at the price P i (1-s i ). P t and Q t are the price and quantity in a market with insurance and subsidies, where individual consumers face a higher price because insurance coverage has been reduced by the Cadillac tax, where individual consumers pay P t (1-s t ). The demand curve is steeply sloped downward, indicating the demand for medical care is relatively inelastic, or changes in quantity demanded are relatively insensitive to changes in price. The supply curve is gradually upward sloping, indicating that the supply of medical care services is relatively elastic, or changes in the quantity supplied are relatively responsive to changes in price. In a world without insurance, consumers pay the full price of medical care (P*) and demand an amount of medical care (Q*) at the intersection of supply and demand. In a world where insurance is introduced, individual consumers pay a share of their full medical costs, P(1-s i ), in the form of a co-payment or other cost sharing and demand Q i amount of medical care. Prices (or cost per unit) in the medical care market increase from P* to P i after the introduction of insurance as suppliers capture a portion of the subsidy. Equilibrium in the medical care market after introduction of insurance occurs with price P i and quantity Q i . In other words, consumers tend to demand a greater quantity of medical care in a world with health insurance compared to a world without health insurance because insured individuals face a lower out-of-pocket cost, P i (1-s i ) as compared with P*. The ESI tax exclusion intensifies the effects that insurance has on the quantity demanded and the prevailing price of medical care in the market because it further insulates consumers from the full price of their medical care decisions. The Cadillac tax effectively reduces (or offsets) federal subsidies for health insurance and reduces that insurance coverage. Thus, it increases consumers' exposure to the full cost of their medical care beyond the Cadillac-tax threshold such that the total quantity of medical care demanded decreases from Q i to Q t and price decreases from P i to P t . The equilibrium after imposition of the Cadillac tax is closer to the equilibrium in the market without the effects of health insurance. The decline in quantity from Q i to Q t largely represents sensitivity to higher out-of-pocket costs (in the form of higher co-payments, deductibles, or other features). The Cadillac tax will affect the overall medical care market by effectively reducing government subsidies for health insurance and therefore reducing insurance coverage, which would likely lead to an increased cost of medical care for the consumer. As medical care becomes more costly, spending on medical care will decrease and spending on other commodities will increase. Although the theoretical prediction is that the Cadillac tax will reduce medical care spending, the revenue raised by the tax is estimated to be a small share of national health expenditures. According to the Congressional Budget Office (CBO), the tax will raise $20 billion in 2025. The Centers for Medicare & Medicaid Services (CMS) project that national health care expenditures covered by private insurance will be $1,752.6 billion in 2025. In other words, revenue raised by the Cadillac tax is projected to amount to 1.1% of projected health expenditures covered by private insurance in 2025. Although the tax is small relative to health spending, its effects can be multiplied through reductions in insurance coverage, as discussed below. Once the tax is implemented, some firms (on behalf of their workers) will retain their plans and pay the tax. Other firms will reduce their insurance and pay their employees more, so that revenue gains will reflect the increase in income and payroll tax paid on the increase in taxable compensation. These additional wages would substitute for previously untaxed health benefits. The reduced insurance coverage would be a multiple of the tax revenues. For example, if the tax rate is 30%, each $30 of revenue collected equals $100 of taxable income and reduced coverage. Thus, each dollar of revenue reflects $3.33 ($100/$30) of reduced coverage.