By David DiLoreto, M.D., MBA, Senior Vice President, and Nicholas Malenka, MHA, CRCR, Senior Consultant, GE Healthcare Partners
Worried about political divisions and the uncertainty of the United States entering World War II, Winston Churchill famously said, “You can count on the Americans do to the right thing…after they have tried all the other solutions.” With federal and state governments now paying over one-half of all U.S. healthcare costs, helping shape public policy is an increasingly important charge for the health industry. The country’s political chasms are greater than ever, and as the recent Tax Cuts and Jobs Act of 2017 (TCJA) takes effect this month we examine how the new law might impact stakeholders in the healthcare ecosystem.
Corporate and Individual Tax Reductions
The big news in TCJA is the significant reduction of corporate tax and marginal rate reduction for most individuals. For the past decade, the United States has had the highest corporate tax rates among industrial nations. Pharmaceutical and medical technology companies stand to benefit significantly from the lowering of corporate rates from 37% to 21%. To judge whether the TCJA tax cuts increase the federal deficit by $1.5 trillion over the next decade (as predicted by the CBO) or stimulate economic growth, increase jobs, and lower the deficit by $600 billion (as predicted by the Treasury Department), watch for signs that the U.S market is becoming more competitive compared to its trading partners among industrialized nations. These signs include the repatriation of foreign profits, relocation of intellectual property, and manufacturing jobs returning to the U.S. This is particularly important for the U.S. life sciences and pharmaceutical industries. Due to the size, profits, and amount of taxes paid by these companies, there is much more at stake in the near term from tax reform than for other healthcare stakeholders. For example, many large pharmaceutical companies are headquartered in the U.S. but have complex global supply chains and international affiliates and use unrelated global suppliers. Re-investment by these firms at home could create a freer flow of capital in the U.S., increasing domestic research, capital equipment purchases, and job growth.
The TCJA keeps seven tax brackets for individuals and lowers marginal rates for all but the highest two. A significant change for individuals is the near doubling of the standard deduction and elimination of the personal exemption. For people who do itemize, the threshold for deducting unreimbursed medical expenses is lowered for the next two years from 10% to 7.5% of adjusted gross income (AGI). This should minimize the impact of higher out-of-pocket costs that individuals may face with their health plan policies.
Impact on Health Plans
The most significant change for health plans is the elimination of penalties associated with the Affordable Care Act’s (ACA) individual mandate beginning in 2019. ACA required individuals who forgo health insurance to pay a penalty of 2.5% of AGI or $695. While health plans and healthcare providers would rather have retained the mandate, it proved to be a weak incentive. The many statutory exemptions, multiple additional enrollment periods, and low levels of enforcement made it less effective than the architects had hoped. Since the ACA coverage requirements and subsidies remain in place, the impact from the elimination of the penalty is difficult to project and estimates vary widely. The CBO projects 4 million additional individuals will be without coverage in 2019 and 13 million more by 2027. Standard and Poor’s model predicts far less impact with no more than 3-5 million uninsured by 2027. While the projections may vary, health plans should factor some loss of healthy individuals from risk pools for plan years starting in 2019, and healthcare providers will do well to anticipate some impact on bad debt.
A counterweight to the elimination of the individual mandate penalty for health plans is the reduction of corporate rate to 21%. The reduced taxes could mitigate the rate of premium increases for consumers since the ACA medical loss rules still require at least 80% of premiums for coverage of individual and small group medical expenses. Even more helpful would be the passage of the Murray-Alexander Bill which aims to continue funding ACA’s cost-sharing subsidies. It would have the dual effects of stabilizing coverage for Americans earning less than 250% of the federal poverty line as well as signaling a bipartisan approach to solutions for fixing current problems in the U.S. healthcare system.
Impact on Hospitals and Providers
Whether TCJA’s lower corporate tax rates, lower marginal rates for most individuals, and the immediate expensing of capital expenditures results in positive gains for the U.S. economy is of critical importance to healthcare providers. If these fail and federal deficits increase, mandatory spending cuts are more likely to impact programs including Medicare, and additional entitlement reform affecting Medicaid becomes more likely. Currently half of all healthcare spending in the U.S. ($1.5 trillion a year) is government spending. This does not consider the value of the additional $400 billion that results from the tax deduction for employer-sponsored health insurance coverage. By comparison, the entire U.S. defense budget is $800 billion a year.
Should federal deficits increase, the Pay as You Go Act (PAYGO) requires automatic spending cuts. According to the CBO projections, TCJA will require a $150 annual billion annual federal budget cut to reduce the projected impact on the federal deficit. The largest of these cuts, $25 billion, would be to Medicare. Fortunately for providers, the TCJA bill includes a one-year waiver from the automatic PAYGO cuts in 2018. But mid-term elections in 2018 will heighten the focus on economic growth, the federal deficit, the looming automatic PAYGO cuts in 2019, and may result in additional debates in Congress over additional PAYGO waivers and potential Medicare and Medicaid entitlement reform.
For 2018 there are other real and tangible TCJA impacts on healthcare providers. Some non-profit systems pay tax on unrelated business income (UBI), which the IRS defines as income from a business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization's exemption. The TCJA now requires that health systems separate these activities and determine whether there is a UBI tax on each one. Previously, these could be grouped, and a tax was paid on net profits. The result for most health systems is likely an added non-recoverable cost burden. Additional tax deductions have been eliminated on certain employee benefits such as transit passes, parking, parking shuttles, bicycle commuting reimbursement, on-site gyms, and meals.
TCJA also includes a new 21% excise tax on compensation that exceeds $1 million per year for the five highest paid employees in not-for-profit and for-profit health systems. This change is a modification from the current rule which excluded performance-based pay and exempted the principal financial officer. Employees who are healthcare providers are exempt from the excise tax. For academic health centers, the law imposes a 1.4% excise tax on university endowments.
Assessing the impact from the tax treatment of UBI, employee benefit structures, the timing of employee compensation and severance payments for top earners, and the excise tax on university endowments should be high on the to-do list in 2018.
In recent years, healthcare related public policy discussions have been ACA-centric--and while that is likely to continue in 2018, the Tax Cut and Jobs Act of 2017 introduces new variables and solutions into the quest for viable healthcare reform. As Congress reconvenes in 2018, there will be more additional and crucial health reform solutions to consider and debate including the renewal of CHIP funding, Murray-Alexander cost-sharing, accelerating the move to value-based reimbursement, introducing more competition into pharmacy pricing, and entitlement reform. Competing for political attention and funding will be an infrastructure bill as well as the automatic 2019 PAYGO federal spending cuts if the projected economic gains from TCJA fail to materialize.
Churchill was prescient in his confidence that Americans arrive at the right solutions albeit after considerable debate and experimentation. Let’s hope it works for U.S. healthcare this time around too.
Source and Background Materials
Distributional Analysis of the Tax Cuts and Jobs Act, as Ordered Reported by the Senate Committee on Finance on November 16, 2017, Excluding the Effects of Eliminating the Individual Mandate Penalty https://www.cbo.gov/publication/53349
U.S Tax Reform: Repeal of the Health Insurance Mandate Will Save Less Than Expected, And Will Not Support the Current Insurance Market https://www.capitaliq.com
Repealing the Individual Health Insurance Mandate: An Updated Estimate on November 8, 2017 https://www.cbo.gov/publication/53300
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David DiLoreto, M.D., MBA Dr. DiLoreto, senior vice president at GE Healthcare Partners, is a physician-executive who is highly experienced in executive management, strategy and operations of healthcare delivery systems, and managed care companies. He has deep management expertise in community-based and academic health systems, large group medical practices, hospitals, and managed care organizations. His areas of specialty include clinical transformation, population health, business process improvement, leadership development, medical informatics, quality improvement and patient safety, and data management and analytics. He may be reached at firstname.lastname@example.org.
Nicholas Malenka, MHA, CRCR Mr. Malenka is a senior consultant with GE Healthcare Partners and has more than six years of experience helping hospitals overcome strategic challenges. He has deep expertise in the impact of consumerism on hospital operations, as well as hospital revenue cycle optimization. Previously, Mr. Malenka worked at the University of Pittsburgh Medical Center where he worked with administration on key priorities, such as a Lean cost reduction effort that included service robots, building a retail pharmacy solution, and enhancing patient throughput for an outpatient respiratory department. He may be reached at email@example.com.