Former Obama Administration official decries PPACA's perverse incentives for low-income Americans

We've known for two years now that Obamacare's patchwork of mandates, employer penalties, and expensive subsidies for the uninsured will disrupt America's labor market and reduce incentives to climb the income ladder - particularly for low-income Americans. Center-right scholars and commentators have been pointing out these problems since the law took effect, but a new paper by University of California law professor David Gamage updates many of the same criticisms.

And what makes his analysis especially powerful is that Gamage is a former Obama Administration official who is otherwise very supportive of the law.

We'll get to Gamage's analysis shortly. But in the meantime, it's worth reflecting that the negative employment and labor effects of the Affordable Care Act aren't accidental - they're a reflection of the political choices that President Obama and Congressional Democrats made that helped them pass the law.

Recall that Congressional Democrats had two conflicting priorities: First, they wanted to cover as many of the uninsured as possible (to reach the Holy Grail of universal coverage). Second, they had to keep the overall price tag for the legislation below $1 trillion and (hopefully) reduce the deficit.

The problem is that the first priority requires large subsidies for insurance coverage, particularly at the low-income end. That makes the bill very expensive, particularly if it encourages employees (and employers) to opt out of current employer-based insurance coverage. So to keep the price tag of their legislation down, Democrats had to institute an employer penalty, hopefully inducing most employers and employees to stay put and keeping the employer-based insurance system intact. Whatever the policy merits of shifting to individual-based coverage (which I support), Obamacare's combination of comprehensive coverage and lavish subsidies far up the income ladder make it awfully expensive.

Democrats thought they could cut the Gordian knot by having Obamacare contain both an individual mandate (encouraging people to buy insurance - the "stick"), rich subsidies (the "carrots", up to 400% of the Federal Poverty Level or about $90,000 for family of 4), and employer penalties (ranging from $2,000-3,000 per employee) to discourage employers from dumping employees into the exchanges (more sticks).

Sound complicated? It is, and we haven't even started talking about how the IRS interpretation of the law will affect how it all turns out.

In its estimate of the law, the Congressional Budget Office (CBO) projected that only 3 million Americans with employer-based coverage would drop that coverage to take advantage of exchange subsidies. However, other experts quickly predicted much higher take up rates, and thus higher federal costs, because the subsidies for some Americans, at the exact same income levels, are much higher on the Obamacare exchanges than they are for employer-based coverage. (At the top end of the income distribution, the tax advantages outweigh the subsidies.)

The gap between exchange subsidies and the tax benefit of the employer-based health insurance coverage is what causes the most mischief. For instance, in a May 2010 American Action Forum report by Douglas Holtz-Eakin and Cameron Smith, Labor Markets and Health Care Reform: New Results, Holtz-Eakin and Smith predicted that many companies and many employees would be better off financially if they dropped employer-based coverage. At 133% of the Federal Poverty Level (FPL), they write, the decision to drop coverage seems pretty clear cut but the incentives stay basically the same even at significantly higher income levels. Holtz-Eakin and Smith note that

For example, at 200 percent of the FPL, the "surplus" between the pay raise required to hold a worker harmless ($4,936) and the firm's cash-flow benefit from dropping coverage ($9,941) has narrowed, but the bottom line decision [dropping coverage] in the final column is the same. Indeed, the incentives are quite powerful up to 250 percent of FPL, or $59,250. Only for higher-income workers do the advantages of untaxed health insurance make it infeasible to drop insurance and re-work the compensation package.

On net, Holtz-Eakin and Smith estimate that there may be as many as 43 million Americans who have employer-based coverage for whom it would make more sense to move to state exchanges. If so, the cost to federal tax payers could be much higher - as much as $1.4 trillion or triple the CBO's initial estimate cost of insurance subsidies ($450 billion).

This isn't the only perverse effect the law generates. Firms (especially firms that employ large numbers of low-income employees) are also effectively encouraged to find new and inventive ways to avoid the penalties for dropping employee coverage or not offering it to begin with - like outsourcing low-income employees, shifting more full-time workers to part-time employment, or substituting technology for labor (or all of the above). "In any event," Holtz-Eakin and Smith write, "the massive federal subsidies are money on the table invite a vast reworking of compensation packages, insurance coverage, and labor market relations."

How easy will it be for employers to drop coverage? Robert Book wrote in Forbes recently that an IRS ruling on how to interpret what constitutes "affordable coverage" for the purposes of paying the employer penalties under the law (there are two of them - one for not offering coverage and one for offering "unaffordable coverage") has left a very large loophole for employers to send employees to the exchanges and avoid paying the penalty for doing so:

What has attracted less attention thus far is a different IRS regulation that could make it possible for most employers to completely, or in some cases nearly, avoid the employer mandate altogether. In theory, the law requires employers to either offer "qualified" coverage or pay a penalty, with another penalty if the coverage they offer is "unaffordable." But as it turns out, the section of the law covering the employer mandate is not so simple.

Affordable employer coverage is pegged to family income - with "affordable" deemed as less than 9.5% of family income. But employers criticized this rule since they have no way of knowing how much an employee's family (spouse, children, or other dependents) earns.

Book explains that the IRS responded to this eminently reasonable concern by proposing an "affordability safe harbor" that employers can use to avoid the penalty based on information they do know: their employee's wages. Employers would not be assessed the penalty if they offer coverage to their employers and dependents, and if, in the language of the Federal Register, "the employee portion of the self-only premium ... does not exceed 9.5 percent of the employee's current W-2 wages from the employer," which the employer knows.

The effect of the loophole is that companies can set the cost of self-only coverage at just below the affordability threshold, say 9.45% (avoiding the employer penalty) and then set the premium for family coverage much higher, allowing those employees to get coverage on the exchanges.

The problem, as Book points out, is that this certainly wasn't what many Obamacare advocates wanted - and would have changed the CBO's final score for the bill, making it much less attractive (from a taxpayer and political viewpoint).

In short, if the public had understood that Obamacare was building a convenient trapdoor under the employer-based insurance system, it would never have passed.

My colleague Diana Furchtgott-Roth also addresses another underappreciated aspect Obamacare: it will discourage marriage and encourage more women to drop out of the labor force. Why? In Congressional testimony last October, Furchtgott-Roth noted that

Two singles would each be able to earn $43,000 and still receive help to purchase health insurance, but if they got married and combined their earnings to $86,000, they would be far above the [federal] limit. As a married couple, the most they could earn and still get government help with health insurance premiums would be $58,000, a difference of almost $30,000, or 32 percent. This is a substantial disincentive to getting married, or to working while married.

Now we come to Gamage's paper. Gamage, an assistant professor at the University of California and a former Special Counsel at the U.S. Department of the Treasury echoes the concerns from Holtz-Eakin, Book, and Furchtgott-Roth that Obamacare creates many perverse incentives for low-income Americans. In his summary, he notes that

The ACA will deter low- and moderate-income taxpayers from accepting jobs with employers that offer "affordable" health insurance;

The ACA will discourage many low- and moderate-income taxpayers from attempting to increase their household incomes;

The ACA will penalize many low- and moderate-income taxpayers who choose to
marry, and will incentivize many low- and moderate-income taxpayers to divorce;

The ACA will dissuade employers from hiring low- and moderate-income taxpayers, and will encourage employers to reduce the salaries paid to some low- and moderate income employees;

The ACA will prompt employers to shift some low- and moderate-income employees from full-time positions to part-time positions;

The ACA will tempt employers to implement a number of other costly strategies for circumventing the ACA's employer mandates and penalties;

The ACA will induce employers to stop offering "affordable" health insurance to at least some low- and moderate-income employees, and - if this occurs to a significant enough degree - the budgetary cost of the ACA may greatly exceed the official projections issued by the Congressional Budget Office.

Apart from that, how was the play Mrs. Lincoln?


The table above shows Gamage's 'break-even analysis' of the impact of exchange subsidies in the ACA. Single employees with just over 225% of the FPL will benefit from the employer not offering (or dropping) 'affordable' health insurance, meaning that all of these employees could flood the exchanges.

To be fair, Gamage thinks that the law was more than worth these problems, and that they aren't inherent in the legislation - Democrats just erred by failing to level the playing field between employer sponsored insurance and the Obamacare's insurance tax credits. Setting a level playing field by equalizing the subsidies regardless of how that insurance is purchased (through employers or on the individual market) would have eliminated these problems, Gamage believes.

He may have a point - and Gamage also concedes that refundable tax credits for buying health insurance is an idea that Republicans have supported for years. But it would've required a massive change in tone and tactics from the President and Democrats in Congress for them to produce a bill that borrowed from the Republican playbook. Recall that candidate Obama eviscerated Senator John McCain for proposing standardized refundable tax credits for buying health insurance during the 2008 campaign. He specifically criticized tax credits as taxing employer-provided health insurance "for the first time".

Making McCain's proposal a centerpiece of Democrats health reform efforts might've produced a huge bipartisan coup for the president and reduced the partisan rancor that has plagued the administration and Congress since the bill passed. But that's not what President Obama did. Instead, we've got the Rube Goldberg contraption that is Obamacare, rife with conflicting features that will distort the American economy and increase federal spending on health care entitlements.

Retooling the tax exclusion for employer-based insurance and undoing Obamacare's perverse labor market and marriage penalties - particularly on low-income Americans - should clearly be at the top of the list of responsible policy decisions in the next administration.

But wouldn't it be easier just to repeal and replace the whole thing with legislation that got the underlying incentives right to begin with?

Related Entries:

keep in touch     Follow Us on Twitter  Facebook  Facebook

Our Research

Rhetoric and Reality—The Obamacare Evaluation Project: Cost
by Paul Howard, Yevgeniy Feyman, March 2013

Warning: mysql_connect(): Unknown MySQL server host '' (2) in /home/medicalp/public_html/incs/reports_home.php on line 17
Unknown MySQL server host '' (2)


American Council on Science and Health
in the Pipeline
Reason – Peter Suderman
WSJ Health Blog
The Hill’s Healthwatch
Forbes ScienceBiz
The Apothecary
Marginal Revolution
Megan McArdle
LifeSci VC
Critical Condition
In Vivo Blog
Pharma Strategy Blog
Drug Discovery Opinion