A modest reduction in health care inflation by itself might increase employment or number of hours worked, but the effect will be overwhelmed by new taxes coming into effect in the next two years.
Health care and the labor market are connected because so much of the non-elderly population obtains health insurance through an employer or the employer of a family member. As the decades have gone by, Americans have been spending more and more on health care, largely through their health insurance premiums, to the point that many families cannot afford the kinds of health insurance plans in which middle- and upper-income families take part.
So it’s reasonable to wonder whether the health expenditure trends affect the amount of employment in the economy, and thereby whether policy reforms that reduce the rate of health expenditure growth might reverse some of those employment effects.
The direction of the employment effects of health care inflation is unclear, because it depends on the reasons for rising health care costs. To the degree that rising costs derive from new, valuable (but expensive) pharmaceuticals and medical procedures, rising costs may make people more attached to jobs with health benefits in order to have better access to medical innovations and to pay for them with pretax dollars.
But health economists have also pointed to less benign sources of health care inflation, including excessive malpractice penalties and a number of other health industry inefficiencies that raise employer health insurance costs without creating commensurate value for employees.
The economists Katherine Baicker and Amitabh Chandra looked at evidence suggesting that malpracticelike sources of health care inflation are economically equivalent to an implicit tax on employers (see Page 612 of their paper). Economists call it an “implicit tax” because it has many economic characteristics of a tax, even though it is not legally a tax; it reduces employee cash wages by the amount of the implicit tax, and incentive-sensitive employees respond by working less.
As the House of Representatives began to consider whether to repeal the Affordable Care Act, David Cutler of Harvard testified about the Baicker-Chandra results and asserted that the Affordable Care Act would reduce average health care costs by about 5 percent by 2015, reduce the health care cost implicit tax on employers and thereby increase nationwide employment more than it would have grown had the Affordable Care Act not been enacted.
He also organized and signed an economists’ letter to Congress asserting that “repealing the Affordable Care Act would produce job reductions of 250,000 to 400,000 annually.” The Affordable Care Act was cutting employer costs and Congress needn’t worry that it would contract the labor market, they wrote.
Neither Professor Cutler’s testimony nor the economists’ letter mentioned that the Affordable Care Act also creates explicit taxes on employers, subsidies for layoffs and various implicit taxes on employees with many of the same economic characteristics as taxes on employers.
Other advocates of the Affordable Care Act dismiss the act’s work disincentives as negligible, because incentives supposedly have little effect on employment and hours worked. At first glance, it might seem that we have a case of dueling experts, and that we’ll never know which effect dominates. But that first impression would be incorrect, because each effect cited above – like the employer mandate or the health care cost reduction – is a tax effect, and simple arithmetic is all that is needed to determine the direction of the combined effect of all of the tax-like provisions.
After I sent Professor Cutler a draft of this post, he responded: “When I was giving my testimony, I was excluding the vast bulk of policies that will affect part-time work, job choice, etc., because I wanted to focus on the overall cost issue. I don’t think you can do this right unless you include all the effects.”
He agreed with me that readers of his testimony and letter might get the wrong impression that “repealing the Affordable Care Act would produce job reductions” refers to the act as a whole, when it fact it refers to the cost-reduction provisions by themselves. (He also said that neither his testimony nor my calculations quantify the effect of the health care law on job mobility and on the health of the work force, and that he believes these two employment effects to be large. I will return to those issues in a later post.)
Furthermore, Professor Cutler told me he left out explicit and implicit tax effects because he believed (and still believes) them to be less than the cost-reduction effects, and because he “didn’t have a way to add them all up,” referring to the various effects. Since Professor Cutler’s testimony, I have shown how most of the effects can be added together because cost reduction is a tax effect comparable to the tax effect of the employer mandate, the tax effect of the subsidy for layoffs and so on (see also the methodology in Chapter 3 of my book “The Redistribution Recession”).
Begin with Professor Cutler’s (probably optimistic) estimate that the act will reduce employer health costs by 5 percent as of 2015. Because of the special payroll and income tax treatment of employer health insurance, 1.5 of those five percentage points of savings will accrue to government treasuries, leaving 3.5 percentage points of health care savings for employers and employees. Americans spend about 18 percent of their gross income on health care and 82 percent on other things: saving 3.5 percent on health care is like saving 0.6 percent on their total budget.
(In principle, the government treasuries could use their savings to cut marginal tax rates or increase them less than they would have. But they could also use the savings to pay for additional assistance programs that erode work incentives, so I take the middle ground and assume that the government savings by itself has no effect on marginal tax rates.)
Some cost-reducing provisions in the Affordable Care Act, such as the tax on “Cadillac” health plans or the Independent Payment Advisory Board, may reduce value received by employees at the same time that they reduce employer costs, and therefore affect employment less than cutting implicit employer taxes does. The implicit tax cut effect associated with the act’s cost reductions (as estimated by Professor Cutler) is therefore somewhere in the range of 0.3 to 0.6 percentage points, with the 0.6 percentage point case representing the extreme where none of the cost-saving measures reduces employee value.
The Affordable Care Act’s explicit taxes on employers, subsidies for layoffs and implicit taxes on employees, together amount to a five or six percentage point addition to the average marginal tax rate on labor income (this includes the fact that many people will not take part in programs for which they are eligible, the tendency of the act to move people off means-tested uncompensated care and the fact that the act implicitly taxes unemployment benefits, as I noted in testimony before the Human Resources Subcommittee of the House Ways and Means Committee). By these calculations, the tax effects that Professor Cutler left out are about 10 times greater than, and in the opposite direction of, those he conveyed to Congress.
Professor Cutler projected that the Affordable Care Act’s cost reductions by themselves will increase employment in 2015 by about 400,000, or about 0.3 percent of total employment (see Figure 2 in his testimony). If his estimate of the cost-savings channel is accurate, and I am right that the overall labor market effect of the act is about 10 times larger (in the other direction) than the cost-savings channel, we might then expect the act to contract the 2015 labor market by about 3 percent rather than expand it.
As time goes by and additional research results become available, it increasingly appears that even the experts failed to fully appreciate the labor-market-depressing effects of the Affordable Care Act at the time it was passed.