Work Now, and Let Uncle Sam Pay You Later

Copyright, The New York Times Company

Notwithstanding quirks in the Social Security system, public policy has sharply reduced the reward to work since 2007.

On Monday, the Economix blogger Nancy Folbre helped explain some of the complex factors that determine the rewards of working. Among other things, she noted the roles of work experience and Social Security benefits, both of which are examples of future consequences of working in the present.

This week I will examine Social Security and Medicare benefits from her forward-looking perspective, and in a future post I will examine work experience.

Professor Folbre says the payment of Social Security payroll taxes confers a benefit on the taxpayer in the form of additional Social Security benefits later in life. Indeed, the Social Security Administration calls the payroll taxes “contributions,” although employers are subject to penalties and even prosecution if they fail to deliver the “contributions” on time and in the legally prescribed amounts.

Technically, a worker’s lifetime history of taxable earnings, rather than the taxes themselves, traditionally determine a person’s old-age benefits, with more lifetime earnings sometimes resulting in more benefits (this book by the longtime Social Security actuary Robert J. Myers has all the details).

A classic paper by Martin Feldstein and Andrew Samwick was able to quantify the the link between lifetime earnings and old-age benefits as it was in 1990, assuming that Social Security rules would be unchanged over the next several decades. They found that secondary earners — in their view, spouses with significantly lower lifetime earnings than the other partner — would receive no future old-age benefits as a consequence of working, but that the value of benefits to patient, primary earners nearing retirement could be significant, especially if they were married.

If payroll taxes were always the same share of taxable earnings, we could ignore the distinction between the two for the purposes of quantifying incentives to work. But payroll tax rates have varied over time, most recently with the partial payroll tax holiday of 2011 and 2012 (interestingly, the Obama administration refers to the two-point reduction as a “tax cut”). Because the payroll tax rates are higher now than in 2012, a person moving earnings from 2012 to this year would increase his payroll tax but not increase his Social Security benefits.

That’s why I count the entire payroll tax cut as an increase in incentives for as long as the cut lasted, even if the rest of the payroll tax confers the benefits that Professor Folbre contends. If all we wanted to know was the amount by which incentives changed over the last 10 years or so, Professor Folbre’s assertion about the future pension benefits conferred would hardly be relevant, unless we thought that the link between present earnings and future benefits had been changing during that time frame.

I agree with Professor Folbre that the best quantitative estimate of marginal tax rates would account for the future consequences of working in the present, but writing in 2013 I am not willing to follow Professors Feldstein and Samwick and assume that Social Security rules will remain unchanged for the remaining lifetimes of today’s workers. In one way or another, we can expect health benefits or cash benefits for the elderly, or both, to be taxed or means-tested more than they are under current law.

Democrats have suggested means-testing Social Security and Medicare, with the likely result that people who worked and saved more during their lifetimes will find themselves with fewer benefits from those programs, compared with people who worked and saved less. Republicans have proposed means-testing Medicare, as part of transforming it to a health insurance premium-support program. The common denominator here is means-testing and the marginal tax rates that go with it.

Professor Folbre is unwilling to assume that “taxpayers derive no marginal benefits from programs such as Social Security.” But that’s hardly relevant for understanding how incentives evolve over time. Based on the considerations cited above, my guess is that the effect of working in the present on future Social Security and Medicare benefits was once somewhat positive (primary earners) or zero (secondary earners), and for primary earners has become less positive (or even negative) over time. By approximating these changes as zero, my work has thereby understated the amount by which marginal labor income tax rates have increased since 2007.

Regardless of whether redistribution is achieved by collecting more taxes from families with high incomes, providing more subsidies to families with low incomes, or both, an essential consequence is the same: a reduction in the reward for activities and efforts that raise incomes. New and revised federal programs do exactly that, in myriad ways, and will be doing so for the foreseeable future.

New Video on the Affordable Care Act and the Labor Market

2014 Marginal Tax Rates without the Individual Mandate

The odds of a one-year delay of the individual mandate have been rising since October 1. The work I did in August 2013 assumed that the individual mandate took effect 1/1/2014 as scheduled by the original law, and that the addition to marginal tax rates on that date would average 3.7 percentage points. Table 5 gives some of the details of the derivation.

The colored circle and rectangles show the ingredients that would change if the individual mandate were delayed beyond 12/31/2014. The red circle entry would become zero, which by itself would reduce the bottom line from 3.7 percentage points to 3.6 percentage points.

I based my estimates of the green rectangle's three parameters on rollouts of Medicare, Medicaid, and ARRA COBRA subsidies, none of which were supported by an individual mandate. Moreover, the most important of the three entries is the first one, representing unemployment, and I expect that the individual mandate will not apply to many unemployed people anyway. Arguably the green rectangle's entries would be the same without or without the individual mandate.

The blue entries are based on expectations of take-up of the exchange plans among workers who are not offered affordable coverage at work. Perhaps they would be cut by one third by eliminating the individual mandate for 2014, which would put the bottom line at about 3.3 percentage points.

[Added: If people without employer insurance do not begin their exchange coverage (perhaps because they don't have to because of the administrations new ruling) until 4/1/2014, their income between 1/1/2014 - 3/31/14 will still count toward their subsidy, but their subsidy will flow only for the last nine months of the year. The marginal tax rates from this scenario are therefore uniform throughout the year but the amount is 1/4 of the way from 3.7 percentage points (individual mandate all year) to the 3.3 percentage points with no individual mandate during the year).]

More important than the individual mandate is the take-up rate of subsidized exchange plans. If healthcare.gov fails and take-up was 1/3 of what was expected, the bottom line with the individual mandate would drop from 3.7 to 1.8 percentage points (see especially Table 8 of my paper). The health of healthcare.gov and the health of the labor market are inversely related.

Since October 1, Obamacare has created positive social value

The best industrial organization economists understand that products have many attributes. Coca-Cola is not simply a substance for quenching consumers' thirst. Consumers value its brand image, familiarity, packaging, etc., which is why it dominates competing sodas despite tasting the same.

I urge Obamacare critics stick to legitimate critiques rather than fabricating them through economic misunderstandings. For example, healthcare.gov was supposedly built at a cost of over $600 billion. Although I agree that healthcare.gov has delivered hardly any value by enrolling (a handful of) people in health insurance, we cannot conclude that the social value created by Obamacare since October 1 has been negative.

First, the social purposes served by healthcare.gov go beyond enrolling people in health insurance, just as the social purposes of Coca-Cola go beyond quenching thirst. I am no fan of Obamacare and thereby don't bear the burden of proof of said value, but can point to entertainment value as an example. Many times lousy unknown films make $50 million in a few months, and that understates the social value created because intellectual property like films cannot monetize all of the social value. I'm confident that healthcare.gov has created more aggregate entertainment than, say, The Smurfs 2 or The Last Exorcism Part 2, which, in the span of a few months, each generated social values in the $20-120 million range.

Millions of Americans are chuckling over videos like these:

You might say that the enjoyment is offset by the pain experienced by Obamacare supporters when they view such videos. But as of October 1 there weren't that many Obamacare supporters (why would NBC and other major networks feature this kind of entertainment if it were offensive to half of the potential viewers?), and the few of them who exist can and do choose to ignore the allegedly major problems with healthcare.gov.

Like international trade, farce is usually a positive-sum game. My best guess is that the entertainment value generated by healthcare.gov during October 2013 is about $200 million, with more value forthcoming, albeit at a diminishing rate.

Second, healthcare.gov didn't cost $600+ million to build. Nobody knows for sure (that's part of the entertainment value!), but healthcare.gov appears to cost $125-150 million. If healthcare.gov created value only via entertainment, it has already generated a surplus in the neighborhood of $50 million.

As I said, healthcare.gov has still more valuable product attributes. Somebody needs to quantify the value of reminding the public (and economists) about "Bright Promises, Dismal Performance" better than Milton Friedman ever did. Who knows what corruption might be uncovered in the Congressional hearings -- corruption that would have persisted undetected but for healthcare.gov.

The Power of the Individual Mandate

Copyright, The New York Times Company

If and when the Affordable Care Act is executed as planned, it will leave few members of working families uninsured.

About 31 million members of nonpoor working families are without health insurance (according to my calculations from the Census Bureau’s current population survey). An important reason they do not have private health insurance coverage is that, in one way or another, they find it too expensive. Their employer may offer health insurance, but they decline coverage because the premiums are too much.

If their employer doesn’t offer insurance, the uninsured workers are, judging from their behavior, unwilling to switch to an employer that does offer health insurance in exchange for lower cash pay (of course, finding such an employer may not be easy and may require a move across state lines, but that’s my point: getting private insurance is costly).

The Affordable Care Act has at least two provisions to make insurance cheaper to workers who have so far been uninsured, compared with what employer insurance would have cost them in previous years, and these will take effect in the next couple of years (or whenever the federal government gets its systems running, whichever comes later).

The first provision is the “individual mandate penalty” for being uninsured, which will eventually reach the greater of 2.5 percent of husband-and-wife income, or $695 per uninsured family member (up to three, with uninsured children counting half, and the $695 indexed to inflation). Undocumented immigrants are not liable for the penalty.

The penalty effectively makes insurance cheaper because people can avoid it by getting insurance. In effect, all nonpoor legal residents pay the penalty, but people who purchase health insurance get their penalty applied toward their health insurance premiums.

The law’s premium assistance tax credits are another provision that makes insurance cheaper, at least for uninsured nonpoor people living in households below 400 percent of the federal poverty line.

These two provisions are a potent combination — and might be reinforced by the prospect of Internal Revenue Service enforcement of fines due.

I estimate that nine million of those who would have been uninsured without the law will find their own health insurance to be free, or even better, in the sense that their penalty (in the years 2016 and beyond) for being uninsured exceeds the premium that they probably would pay on the law’s new health insurance marketplaces (I use the Kaiser Family Foundation calculator to make these estimates because the marketplaces are not yet operational). As taxpayers, each of these families will be helping to pay for other people’s health insurance; those taxes will be owed regardless of what the family decides about its own insurance.

Without the individual mandate, those nine million people might be tempted to remain uninsured.

Although the remaining 22 million nonpoor workers (and their dependents) will have to pay something to have health insurance, most of them will find insurance to be cheaper than it was before the Affordable Care Act. In addition to the nine million who will find insurance to be free (in the sense defined above), another 13 million will find insurance to be at least 25 percent cheaper than it was to get employer insurance before the law passed, and they are therefore more likely to purchase it.

The individual mandate is politically unpopular, and we don’t yet know how vigorously the Internal Revenue Service will enforce it. The law precludes the I.R.S. from criminally prosecuting taxpayers who refuse to pay their penalty, and on this basis some observers have predicted that the I.R.S. will collect hardly any penalties. Others believe that the I.R.S. can get its penalty revenue if it tries hard enough.

After all, banks and other private-sector creditors cannot criminally prosecute either, yet they still manage to collect from most of their borrowers. Senator Tom Coburn, Republican of Oklahoma, explains how the I.R.S. can add penalties and interest to unpaid individual mandate penalties and establish a lien against the delinquent taxpayer’s property so that, should the property be sold, sales proceeds can go toward paying the I.R.S. The I.R.S. can also press delinquent taxpayers for payment.

The Affordable Care Act prohibits the I.R.S. from filing a Notice of Federal Lien, which would give its lien priority over other liens, but, again, that makes the I.R.S.’s collection toolbox more like the toolbox that private-sector creditors have.

For all of these reasons, the individual mandate can be enforced and thereby help discourage millions of people from going without health insurance.

Aging, Taxes, and the State of the Labor Market

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As people age each year, that tends to increase average ages. At the same time elderly people die and babies are born, and that tends to decrease average ages. The combination of these two forces can keep the average population age constant over time.

The baby boom from the late 1940s to early 1960s changed this calculus, because the number of babies born in those years was well above normal. Average ages fell when the baby boomers were born, and have risen thereafter because the baby boomers’ birthdays tended to outweigh the arrival of subsequent birth cohorts.

For decades, people tended to reduce the amount they worked – especially through retirement – as they reached 62 and beyond, because their health declined, they became eligible for Social Security, they wanted to spend time traveling or they looked forward to extra time with grandchildren. Still, retirement behavior need not reduce total workers per capita because people turning 62 can be replaced by young people coming into the work force.

In about 2008, the first baby boomers started to reach normal retirement ages. Their numbers are so large that the people coming out of school are too few to fully replace them. This historically unusual rate of population aging is expected to reduce employment per capita.

You might say that the natural rate of employment has been falling in recent years, for labor supply reasons that have nothing to do with the recession, financial crises and other economic events.

For this reason, in my book and elsewhere I look at labor time series that are adjusted for population aging. The chart of work hours per person below is an example. The chart is on an index scale, with the last month before the recession normalized to 100. An index value of, say, 90, means that hours per person were 90 percent of what they were in December 2007: a drop of 10 percent.

Calculated with data from the Bureau of Labor Statistics, the Census Bureau and the Bureau of Economic Analysis

The red series shows that, without any adjustment, the labor market is still about 6 percent below what it was: less than half recovered from its 10 percent drop. But the recovery is more significant if we adjust for age: the gray series had reached 96.3 by August 2013.

In other words, two of the six percentage points of the current depression of the red series is a consequence of population aging between 2007 and 2013. Because the Federal Reserve and other policy makers cannot stop the aging process and the labor supply shifts that go with it, they should understand that their job of helping recovery will be finished before the red series gets back to 100.

Economists disagree about many things, but they seem to agree with the basic idea that the lack of recovery is partly attributable to population aging, and that policy makers cannot stop the aging process. Paul Krugman, for example, notes that we need to adjust for demographics. He uses a slightly different adjustment, but his measure and mine agree that population aging by itself depresses the usual labor market indicators by 1 or 2 percent.

But aging is not the only change affecting labor supply. Marginal tax rates have increased five percentage points since 2007 and will increase another five percentage points over the next 15 months, a trend attributed especially to expansions in health and other safety net programs. By 2015, a typical worker will keep only half of the value created by employment, compared with 60 percent kept before the recession.

Economists have traditionally recognized that a 17 percent reduction in the reward to working (from keeping 60 to keeping 50) would significantly contract the labor market, and do so at least as much as the 2 percent that the aging of the baby boom does. Yet this time many economists are reluctant to acknowledge marginal tax rate increases, even though marginal tax rates affect labor supply in many of the same ways that aging does.

Perhaps the economists who are silent about marginal tax rate hikes are worried that acknowledging the new rates would overshadow their well-intentioned origins: helping the poor, the unemployed and people without health insurance.

Professor Krugman, for example, says life is too short for him to look closely at my criticism and at the marginal tax rates I’ve measured, and doesn’t indicate that he’s looking at anyone else’s measures either. He’s not the only one: I have visited several Federal Reserve banks since 2009, and hardly any of the economists there seemed to be aware of what’s happening to marginal tax rates.

The Federal Reserve cannot reverse the tax rate increases any more than they can reverse the aging process. Perhaps Congress should ask Janet Yellen, nominated as chairwoman of the Federal Reserve, what she knows about changes in tax and retirement rates, and what they say about the future of the labor market.

People are already advised to reduce their income

One of the myths about explicit and implicit taxes is that Americans have no clue what's going on, and cannot react to tax rates of which they are purportedly ignorant. That's wrong on many levels, one of which that less than two weeks after the Obamacare launch, personal finance columnists began advising readers to watch their income and consider cutting it in order to enhance their subsidy.

You might attempt to reconcile these two by assuming that nobody reads such columnists, except that the one column I linked has been shared thousands of times on facebook and I assume read by tens of thousands.

HT Tom Daula

Two posts on the sales tax and work incentives

If you want to measure the incentive for working, the sales tax needs special consideration.

(A)  Arithmetic.  Think of it this way:

(Disposable income) = (Total income) - (income taxes) - (sales taxes)

Sales taxes are levied as a percentage s of one's disposable income: namely, when you buy a dollar's worth of items at the store you get an extra sales tax charge of s dollars. Income taxes are, for simplicity, a fraction t of income. We have:

(Disposable income) = (Total income) - t*(Total income) - s*(Disposable income)

Equivalently:

(Disposable income) = [(1-t)/(1+s)]*(Total income)

(B) Labor supply behavior.  In order to understand how labor supply behavior changes in response to tax rate changes, to a first approximation all we need to know is the percentage change in [(1-t)/(1+s)]. Over the past 10 years, U.S. sales taxes (levied at the state and local levels) have hardly changed, which means that the time series for t, which is what I showed in my WSJ article, is all we need to calculate the percentage change in [(1-t)/(1+s)].

John Cochrane explains this further on his blog. Today I gave an example, from the U.K., where sales tax rates were NOT constant.

The U.K. example also reminds us how the sales tax is included in the CPI so that, if you do have a marginal tax rate measure inclusive of the sales tax, you should NOT multiply it by a real wage deflated by the CPI because that would double-count the sales taxes. The MTR series that I showed in my WSJ article (and available here in excel format) does not include sales taxes, and therefore can be multiplied by wages deflated by the CPI.

Indeed, economists researching wages should make this multiplication more often than they do (which is hardly ever), because taxes are part of the functioning of prices in the labor market.

(C) Welfare analysis.  If you want to calculate the new deadweight losses from new income taxes, you have to consider the sales tax and any other other wedge between total income and disposable income, even if the sales tax were constant over time, because the behavioral changes avoiding the new income taxes have the side effect of reducing sales tax revenues.  That's what I do in the small section of my book (Appendix 4.3) that quantifies labor market deadweight losses.

Public Policy and Wages in the US and UK

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Between 2009 and 2011, the value-added tax in Britain increased to 20 percent from 15 percent. (The value-added tax is essentially a national sales tax.) Because the tax is part of the overall price of essentially anything bought in the country, it was no surprise that the rate of inflation of prices on consumer goods was elevated during those years as businesses passed on the cost of the taxes they paid to their customers.

In many circumstances, wages roughly keep up with consumer price inflation as the sellers of consumer goods use their extra revenue to compete for workers. But wage inflation is not guaranteed when consumer price inflation comes from sales tax increases, because the extra revenue goes to the public treasury in the form of sales tax receipts rather than going to the sellers of consumer goods.

In this way, increasing the sales tax rate to 20 percent from 15 percent should reduce real wages by 4 or 5 percent. (By real wages, I mean the resources that a person has as a consequence of working after taxes, subsidies and inflation. Because of taxes and subsidies, those resources are less than the aggregate economic value created by working and less than the cost to employers of having employees on the payroll.)

A recent study of wages in Britain confirmed this: inflation-adjusted wages fell 4 or 5 percent in Britain between 2009 and 2011.

While British workers saw their purchasing power eroded by the sales tax increase, the unemployed did not, because unemployment benefits in Britain are automatically indexed to inflation. Additional inflation of 5 percent meant a 5 percent rise in unemployment benefits. By giving a raise to the unemployed without giving a raise to workers, the added sales tax in Britain reduced the reward of working.

The United States does not have a national sales tax. A few states did increase their state sales tax rates between 2011 and this year (others decreased it), but the national average increase since 2007 has been only a couple of tenths of a percentage point.

Nevertheless, adjusted for taxes, subsidies and inflation, wages are lower in the United States, too. As I showed in a post last year (see especially the second chart), public policies in the United States reduced real wages by increasing the incomes of unemployed people through new unemployment benefits, food stamp expansions and other increases in benefits of the social safety net.

As long as the United States and Britain retain their wage-depressing public policies, neither country should expect its labor markets to return to what they used to be.

Ungated version of my marginal tax rate paper

http://caseybmulligan.com/MulliganMTRACA.pdf

excel spreadsheets with the marginal tax rate series are here (use the version with "update" in the file name).