Average Marginal Labor Income Tax Rates under the Affordable Care Act

            Healthcare is valuable but expensive.  As a result, many people believe that poor and middle-income households should pay less than full price for their healthcare, and the United States now has its Affordable Care Act (hereafter, ACA) that will soon implement such a policy.

Economics tells us that redistribution typically comes at the cost of reduced incentives to work and earn, yet some economic analyses of the ACA’s labor market effects do not even mention explicit or implicit taxes (Cutler 2011).  Others note the ACA’s employer penalties, without acknowledging that the Act also includes various implicit taxes on the employee side (Gruber 2012) (Cutler and Sood 2010).  The purpose of this paper is to quantify the contributions of various ACA provisions to time series for the marginal tax rate on labor income.  In doing so, I prepare the estimates so that the various provisions can be compared with each other, compared with other explicit and implicit taxes, put in a historical context, and aggregated with each other for the purpose of aggregate labor market analysis.

The results are startling. The ACA includes both positive and negative tax rate effects, but nonetheless all provisions combined raise marginal tax rates in 2015 by 10 percentage points of total compensation, on average, for about half of the nonelderly adult population and zero percentage points for the rest.  From an aggregate point of view, the employer penalties by themselves are historically significant but nonetheless smaller than each of two of the ACA’s implicit tax provisions.  The ACA will increase the national average marginal labor income tax rate about twelve times more (sic) than the 2006 “Romneycare” health reform law increased the Massachusetts average rate.

Five percentage points is large by historical standards.  While it lasted, the payroll tax cut of 2011 was one third of the magnitude of the ACA’s tax rate hike.  Several SNAP (formerly food stamp program) expansions in combination were a quarter of the ACA’s magnitude.  In terms of its impact on average marginal tax rates, the ACA hike is almost double the effect of permanently increasing unemployment benefit payments to 99 weeks from a baseline of 26 weeks (Mulligan 2012). 

            The ACA has not been introduced into a tax-free economy, so its marginal tax rate hikes add to marginal tax rates already in effect.  I estimate that, by 2015, the average marginal after-tax share among household heads and spouses with near-median weekly earnings will have fallen to 0.50 from 0.60 in 2007, largely from the ACA but also from other expansions in safety net programs.  That is a massive 17 percent reduction in the reward to working – akin to erasing a decade of labor productivity growth without the wealth effect – that would be expected to significantly depress the amounts of labor and consumer spending in the economy even if the wage elasticity of labor supply were small (but not literally zero).  The large tax rate increases are the primary reason why it is unlikely that labor market activity will return even near to its pre-recession levels as long as the ACA’s work disincentives remain in place.

The results account for the fact that many people will not participate in programs for which they are eligible, the tendency of the act to move people off of means-tested uncompensated care, and the fact that the ACA implicitly taxes unemployment benefits.  Although parts of the ACA build “notches” and “cliffs” into household budget sets – that is, infinitesimal income intervals over which marginal tax rates are infinite – my quantitative results are not a consequence of those notches or cliffs.