Obamacare Tax Credit Issue Could Head to Courts

Published November 1, 2012

A new legal challenge could be brought against President Obama’s law over questions about the federal government’s ability and legal authority to set up the health insurance exchanges critical to the law’s implementation.

At issue are a few missing critical words in the health care law. Obama’s law allows state-run exchanges to offer the tax credits and assess the penalties integral to Obamacare, but there’s no language authorizing the feds to perform the same function.

Michael Cannon, director of health care policy studies at the Cato Institute, said the missing language explains a last-minute Internal Revenue Service (IRS) rule change—a revision he maintains is illegal, designed to collect cash for federal exchanges that are otherwise unfunded.

“It’s called taxation without representation,” said Cannon. “It’s called taxation without congressional authorization.”

Flawed Funding Mechanism

Under Obama’s law, a health insurance exchange operates as a virtual marketplace in which people can purchase coverage from government-vetted insurers. The exchanges will cost money to run, but the text of the law only authorizes state-run exchanges to collect the cash and disburse the tax credits which are essential to the functioning of Obama’s law.

As many as 30 states, however, have refused to set up state exchanges or have made no progress toward creating them. That would leave the federal government to establish the exchanges—without the revenue to operate them.

“There is no funding in Obamacare for a federal exchange—none,” Cannon said.

Cannon and his colleague Jonathan Adler, a professor at Case Western Reserve University School of Law in Cleveland, wrote in an extensive analytical paper that the IRS tried to correct that shortcoming in the law with its announcement after 6 p.m. on a Friday night in May that tax credits and revenue can be funneled through federal exchanges, too. Cannon and Adler argue that circumvents congressional authority, and it will soon be challenged in the courts.

Federal Taxpayers on the Hook

Even with the cash collected by the IRS in the form of penalties assessed on noncompliant individuals and companies, the federal government will be forced into massive deficit spending to operate the exchanges, Cannon and Adler say.

The Congressional Budget Office estimated that in the unlikely scenario in which no states create exchanges, the operation of federal exchanges could cost the government $1 trillion or more over the next decade, offset by roughly only $172 billion collected from penalties. States that create their own exchanges will likely have to rely on deficit spending, too, as the federal government provides only start-up money, not operating costs, said Adler.

“On balance, this rule is a large net tax increase,” Adler and Cannon testified in August before the U.S. House Committee on Oversight and Reform. “For every $2 of unauthorized tax reduction, it imposes $1 of unauthorized taxes on employers and commits taxpayers to pay for $8 of unauthorized subsidies to private insurance companies.”

What Did Congress Intend?

Defenders such as Timothy Jost, a law professor at Washington and Lee University in Virginia, argue federal exchanges were always meant to manage tax credits and revenues, and that the May IRS rule change is merely a clarification.

“I think they ignore the history of the bill, they ignore the structure of the bill, and they pick on a couple of particular phrases of the legislation and say that’s the only language in the legislation that matters,” Jost said.

Jost said it “never occurred to anybody” that federal exchanges wouldn’t be able to issue tax credits. He predicted the courts would defer to the IRS.

“They’ve come up with an interesting legal argument here,” said Jost. “They’ve convinced a few tea party legislators that there’s something there. But if it ever gets to court, the courts aren’t going to have too much trouble with this.”

Jost and other critics claim no business or individual could file a lawsuit earlier than 2014, once the penalties are in place, because of the Tax Anti-Injunction Act, which bars suits to restrain taxes before they’re levied. But Adler said he thinks the act won’t apply here, in the same way the Supreme Court justices in spring oral arguments over the health care case decided they could move forward with the case even though the penalties hadn’t come into play.

Could Void Entire Law

Yet Adler and Cannon say the law is clear. And if the IRS rule is eliminated through the courts, Congress, or another IRS administrative rule change, states could opt out of the health care law with no penalties—making Obama’s law essentially void.

“Either it’s intentional—in which case, it’s the law—or it’s a mistake, in which case, it’s still the law,” Cannon said.

But whatever happens, Adler said this hiccup in the law illustrates a greater point.

“This is a massive piece of legislation [for which] people did not spend the time to understand how the pieces fit together,” Adler said. “My own view is, that’s not a responsible way to legislate. And this is but one example of many things I think will be found in the law as people try to implement it.”

Kathryn Watson ([email protected]) is an investigative reporter for Old Dominion Watchdog.

Internet Resources:

Michael Cannon and Jonathan Adler: “Taxation Without Representation: The Illegal IRS Rule to Expand Tax Credits Under the PPACA”: Health Matrix. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2106789