Understanding Health Insurance Subsidies

Subsidies—whether people see them positively or negatively—have been a hot topic since the Affordable Care Act was signed. Lately, many enrollees have turned their attention to this aspect of healthcare.

While lawmakers are still debating the future of healthcare affordability, it’s easy to think that the subsidies tied to the ACA are the only taxpayer-funded health insurance supports in the U.S. system. However, that’s not entirely correct.

According to Larry Levitt, the executive vice president of health policy at KFF, most people with health insurance receive some form of federal help, whether it’s Medicaid, Medicare, the ACA, or employer-sponsored plans. Yet, these broader taxpayer supports often get overlooked since they mainly pertain to work-based insurance. Let’s break it down.

Total Tax Reduction Amount

Nearly half of the estimated $1.1 trillion spent annually on Medicare, the second largest federal program after Social Security, is funded by general federal funds, while the rest comes from payroll taxes and premiums paid by participants—serving over 66 million people.

Medicaid, which is the largest health insurer in the nation, provides coverage for over 70 million low-income individuals and costs around $918 billion yearly. It’s funded jointly by the federal government (65%) and states (35%).

Moreover, taxpayer dollars cover part of the expenses for both programs, but less obvious federal assistance comes through employer-sponsored health insurance. This support appears less visible in federal revenue, as hundreds of billions go uncollected in the form of tax breaks for employers and employees.

Michael Cannon, director of health policy research at the Cato Institute, remarks that employer-sponsored insurance is distinct from other programs because it doesn’t involve direct government payments to individuals.

This type of insurance protects at least 154 million people—compared to about 22.9 million enrolled in ACA plans—who generally do not have job-based insurance. Extending the enhanced ACA subsidies, which expired at the end of 2025, is projected to cost about $350 billion over a decade, or roughly $35 billion each year.

In fact, contributions to employer-sponsored health plans represent the biggest income exclusion in federal budget terms, a tax policy that allows specific income to avoid taxation. The estimated value of this exclusion this year stands at approximately $451 billion, according to the Congressional Budget Office.

Employers can deduct health insurance expenses as business costs, and employees receiving this benefit are not liable for income or payroll taxes on its value. This can be a significant financial benefit, often amounting to hundreds or thousands of dollars each year—though the most generous subsidies tend to favor those with high-cost health plans and higher salaries. Contributions to health savings accounts also fall under certain tax benefits related to health insurance.

Despite this, many insured individuals still contribute part of their paychecks to health insurance, making this exclusion complex to grasp. Larry Levitt notes that to most people, it doesn’t really feel like a subsidy—they think they are simply paying for it.

Incorporation into the Tax System

This tax benefit developed along with workplace health insurance policies in the U.S., arising during World War II when wage controls incentivized businesses to offer health insurance as an employee perk. It was formally established as tax law in 1954.

Supporters, including labor unions and employers, argue it promotes health insurance offers among large corporations. However, small businesses often shy away from providing insurance despite tax incentives due to high costs. For employees, a dollar spent on health insurance carries more value than an equivalent wage that would be taxed.

Critics of the tax exclusion highlight the loss of revenue for the Treasury and express concerns that the policy encourages both employers and employees to opt for expensive health plans, potentially inflating overall healthcare costs. They also note that wealthier workers benefit more from these tax cuts, while those funds could be redirected to increase wages.

Currently, there are no proposed bills addressing these tax cuts, but as the federal budget deficit grows, there’s worry among employers about potential policy shifts. Experts in employee benefits predict different outcomes.

Levitt points out that it’s uncertain if changes would truly lead to higher wages for all workers, as some workers have distinctly more bargaining power than others. Over the decades, administrations from Ronald Reagan to George W. Bush have attempted to modify or eliminate these exclusions, but to no avail.

Any alterations could indeed lead to increased revenues but might also result in higher taxes for workers. The question then arises—how might that affect workers’ wages? Would they rise if tax breaks diminish? Such changes would likely create distinct winners and losers.

However, given how many Americans rely on job-based coverage, there is concern that modifying or reducing these exclusions could disincentivize employers from offering health insurance altogether. While some companies might continue to provide coverage due to its role in attracting and retaining talent, others may reconsider because of the associated costs, especially when the average family premium topped $27,000 last year.

Elizabeth Mitchell, head of the Health Purchaser Business Group, emphasizes that companies are evaluating insurance costs carefully and notes a significant increase in those costs. Without some form of tax benefits, employers may rethink whether they want to shoulder those expenses.

In contrast, Cannon claims the current approach restricts workers’ choices, advocating instead for higher wages, even if taxed, for employees to invest in tax-advantaged health savings accounts for medical expenses.

He argues that this system effectively limits a large portion of a worker’s income by placing it in employers’ hands and restricting their choices regarding coverage.

Employers counter that they can negotiate better health insurance deals than individuals could achieve on their own. The ability to negotiate favorable rates with large integrated systems becomes increasingly challenging for individual consumers.

Mitchell disagrees with the notion that tax cuts inevitably lead to inflated healthcare costs due to individuals using more services due to the richness of employer plans. She contends that this theory doesn’t translate well in healthcare since people seek care out of necessity, not from a desire for additional services.