A Tax Foundation report finds that applying payroll taxes to employer-sponsored health insurance would generate $1.6 trillion over a decade while doing less economic damage than lifting the Social Security wage cap. The analysis, published as policymakers confront Social Security's 2032 insolvency deadline and public debt at 101 percent of GDP, compares two paths to shore up the program's finances through tax increases.
The report estimates that taxing employer health benefits would cut long-run GDP by 0.2 percent and eliminate 283,000 full-time equivalent jobs. In contrast, creating a payroll tax "donut hole" that exempts earnings between $184,500 and $400,000 but taxes everything above would raise $819.6 billion over ten years, shrink GDP by 0.7 percent, and cost 843,000 jobs. The health insurance approach brings in nearly double the revenue while inflicting less than one-third the economic harm. Middle-income workers would shoulder the heaviest burden under the health benefit tax, since low earners typically hold less expensive plans or receive Medicaid, while top earners already exceed the payroll tax cap and see minimal change. The donut hole option, which isn't indexed for inflation and would effectively eliminate the wage cap by 2050, concentrates its impact on higher earners.
According to the Tax Foundation analysis, currently untaxed compensation represents a massive potential revenue source: $235.3 billion could come from taxing other fringe benefits like life insurance, $2.4 trillion from ending the income tax exclusion for health insurance, and $396.8 billion from applying income tax to additional perks. The report notes that Social Security remains progressive overall when viewed across a lifetime, replacing a larger share of retirement income for lower earners than for those at the top. Taxing employer health coverage would somewhat weaken the connection between taxes paid during working years and benefits received in retirement, since those premiums wouldn't count toward benefit calculations even as they expand the taxable base.
The report explains that eliminating the health insurance exclusion would improve economic efficiency because the current tax advantage pushes workers to take more compensation as insurance rather than wages. More generous insurance plans typically feature lower deductibles, meaning patients face little of the real cost when they use care, which drives up prices for everyone including those without employer coverage. Taxing health benefits would also push some workers above the payroll tax cap, so their next dollar earned wouldn't face the tax, reducing the penalty on additional work. The authors argue that broadening the tax base through fringe benefits represents a superior alternative to the standard reform playbook of uncapping payroll taxes or raising income tax rates, because it generates substantial revenue while making the tax code more neutral and avoiding higher marginal rates on work.