The Senate Finance Committee proposes to substantially raise taxes on middle- and low-income taxpayers through a misguided excise tax on insurance plans in order to pay for a portion of its healthcare bill. The Congressional Budget Office (CBO) estimates that this tax hike would cost taxpayers more than $200 billion over 10 years, about a quarter of the bill's $829 billion cost.

Despite the intention to hit only high-priced "Cadillac" health insurance plans, the excise tax would fall mostly on low- and middle-income workers in the near future. A better tax policy solution would be to cap the exclusion for employer-provided health care benefits for individuals and use the revenue to provide offsetting tax reductions. This solution would restructure incentives facing health insurance consumers and ultimately reduce health care costs without growing government further.

Under the Senate Finance plan, providers of health insurance plans that cost more than $8,000 a year for individuals ($21,000 for families) would pay a 40% tax on their value above that threshold. A plan that costs $10,000 a year for an individual would face this 40% tax on the $2,000 over the $8,000 threshold. The health insurer would have to pay $800.

Although the insurance companies would make the tax payment, they would undoubtedly pass this cost along to employers purchasing the plans for their workers in the form of higher premiums. Employers would pass that cost on to their workers by lowering other forms of compensation like wages. Once the excise tax is passed on to workers, the result is no different than an increase in their income taxes.

Passing the tax on to workers would result in an effective tax rate that is even higher than the specified 40%. When the insurance companies embed the cost of the excise tax in premiums, the prices of plans will rise. A higher price means the excise tax would be higher, too.

If insurers are able to push the full cost of the tax on to purchasers, this cascading effect could raise the effective rate for the excise tax to 67% -- considerably higher than the 40% specified in the bill.

President Obama has repeatedly pledged that no one making under $250,000 a year will see their taxes increase. The excise tax would break this pledge. Given the problematic features of the excise tax, this tax increase would be far in excess of the income tax rates most Americans pay today.

For example, a worker who earns $34,000 in taxable income today pays a top income tax rate of 15%. But the effect of the 40% excise tax on this worker's wages is the equivalent of a top marginal hike of 167% (assuming he or she does not accept lower healthcare benefits to avoid the excise tax). And this does not even account for the cascading effect.

In place of this misguided and problematic excise tax, the Senate should seriously consider capping the exclusion on employer-provided health insurance. Currently, employer-sponsored health insurance is an untaxed benefit for workers -- a benefit excluded from taxable income. The cap would work much like the cap on a 401(k), limiting the amount of the benefit that is excluded from taxable income. Economists on both the right and the left agree that the exclusion is a major distortion in the tax code and that capping it is necessary to slow the rapid increase in health care costs.

Capping the exclusion would likely increase the amount of income subject to taxation for many low- and middle-income taxpayers. But unlike the excise tax, a cap would not increase the marginal tax rate of those taxpayers. Taxpayers would pay the same top marginal tax rate on the cost of their health insurance premium above the cap as they pay on their wage income -- instead of a much higher, cascading rate. So a taxpayer who pays a top rate of 28% today would pay only 28% on the premiums above the cap.

This reform would generate additional tax revenue. But rather than growing government's share of the health sector, any additional revenues should be used toward a credit for individuals to purchase insurance on their own.

Curtis S. Dubay is senior tax-policy analyst at the Heritage Foundation.