Code Red: Two Economists Examine the U.S. Healthcare System

November 5, 2009

Who really pays for employer mandates?

Filed under: Health insurance,Health Reform,Uninsured — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 4:29 pm

The rhetoric is flying over a key proposal in the newly unveiled House Democrats healthcare bill.  The bill would require businesses to provide employer sponsored health insurance or pay a hefty payroll tax of up to 8%.  The Democrats say this is a matter of fairness.  Businesses that do not offer insurance have an unfair cost advantage over their larger, more conscientious rival firms.   Why not force them to pay for their sins and level the playing field?  Republicans say this is a tax on small business and could not come at a worse time for a struggling economy.

As is the norm for this sort of thing, they are all wrong.

The main problem with the fairness argument is that it assumes workers are somehow duped into taking inferior benefits-challenged jobs at small firms.  The reality is that any employer must offer a competitive package of wages and benefits or workers will take their labor elsewhere.  (This argument is weakened a bit during a deep recession but small business offer rates are low even during boom times, suggesting that this is not about the business cycle.)  So what might a firm offer if not insurance?   Higher wages?  Possibly, though firms that offer health benefits tend to offer higher wages as well.  More flexible hours?  Perhaps.  A friendlier work place?  Maybe?  They might even be willing to accept less qualified workers.  Whatever the case, firms that do not offer insurance (and these tend to be smaller firms) still manage to offer a work environment that attracts workers.

Now suppose we force all firms to buy insurance or pay the tax.  If nothing else changes, jobs at firms that previously did not offer insurance will be much more attractive, because workers will be able to obtain valuable health insurance coverage through the firm or through the government.  But bear in mind that these firms could have voluntarily made themselves more attractive to workers before the tax but did not choose to do so.  There is no reason to expect them to be so attractive now.   It is more likely that these firms will cut wages (or make other changes) so as to make the jobs about as attractive as they used to be.  For example, if employees valued health insurance at $5000, the firms may cut wages by $5000.  The House tax is really a tax on workers.

This is not necessarily a bad thing.  In exchange for lower wages, more workers get insurance, and the value of their wage/insurance bundle remains about the same.  On top of that, we minimize the possibility of uninsured workers falling ill and becoming free riders.  So far, so good.    But this analysis makes two assumptions.  First, the workers value insurance by at least as much as the tax.  Second, firms are not constrained by minimum wage laws.

What if workers do not value insurance at the amount of the tax?  Then the firm cannot cut wages enough to offset the tax and still keep its workers happy.  The firm will have to limit pay cuts and, as a result, at least some of the tax burden will fall on the firm.  This problem is minimized if the government can offer health insurance at a much lower cost than firms can buy insurance in the market.  If this is the case (a big if), workers may value the insurance much more than the amount of the tax, even though they did not obtain insurance on the job, and firms can offset this value through a pay cut.

Unless firms are constrained by minimum wage laws.  I see this as a big problem.  Uninsured workers tend to be low paid workers and the minimum wage recently jumped to $7.25 per hour.  It may be impossible for some firms to cut wages enough to make up for the cost of insurance.

So who does the House bill harm?  Workers who do not highly value insurance and firms paying near the minimum wage.   A surprising outcome, considering that the Democratic party is supposed to favor progressive legislation.

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