Health Care's Labor Problem

Across many categories, the US is exceptional. A few notable examples: we have one of the highest statutory corporate tax rates in the industrialized world; Americans spend more on health care than any other developed nation; and the American welfare state, compared to countries of similar wealth, is relatively small (and more targeted). One can argue back and forth about the merits of these points - for instance, those leaning left would certainly support high (and higher) tax rates on corporations; opponents on the right, however, see these as inefficient and as a drag on the economy. Similarly, ideological perspectives can color one's position on the latter two points as well.

Yet, you would be hard-pressed to find someone of any political stripe who thinks that the uniquely American concept of employer-sponsored health insurance is, on net, good or helpful to the American health care system. Tracing its roots to a poorly-devised Great Depression-era tax break (which allowed employers to treat spending on health insurance as wages, thus being able to deduct it from their taxes - the kicker is that now, health insurance spending is more valuable than wages because health insurance dollars aren't subject to payroll taxes), the American health insurance scheme rests primarily on the insurance that employers purchase for their employees - over 160 million Americans receive insurance in this manner.

This creates a whole host of unintended consequences ranging from bad to very bad to terrible (as is common with many government regulations). For starters, economists tend to agree that employer-provided health insurance tends to depress wages. Because employer-paid premiums are paid pre-tax, the federal government also loses about $250 billion annually from foregone tax revenue. But this isn't all. Employer-sponsored health coverage contributes to a phenomenon known as "job lock," where people remain in a job primarily for the health insurance. This means that the allocation of labor becomes less efficient than it otherwise would be. Lastly, there is a good deal of literature on how relatively generous employer coverage leads to greater health care utilization, which in turn leads to higher health care prices. In short, while employers should certainly be allowed to offer fringe benefits to their workers, it makes little sense to subsidize it through the tax code - after all, health insurance is no better if purchased by an employer than if purchased by an individual.

For all the negative impacts of employer-sponsored health insurance, the "job lock" phenomenon does have one positive effect - it keeps people in the labor force and working. This isn't to insinuate that perhaps the downsides are somehow balanced out - they aren't - but simply to point out a fact. Employer-provided insurance does increase the incentive to remain in the labor force. And a recent paper from researchers at Northwestern University, the University of Chicago, and Columbia attempts to gauge the impact of the Affordable Care Act's (ACA's) insurance expansion on labor supply.

At the core of the ACA are two forms of insurance expansion - one which expands Medicaid, and the other which creates the first ever national system of publicly subsidized health insurance (to be sold through exchanges). The basic functions of the exchanges should be clear to most readers of this blog by now - individuals with incomes between 100% and 400% of the Federal Poverty Line (FPL) will receive federal subsidies for the purchase of individual health coverage through state exchanges. Those below 139% of FPL, depending on the state they live in, may be eligible for expanded Medicaid coverage (which is effectively free for the individual). As the study's authors note, "The ACA will weaken the link between employment and health insurance through the creation of a series of state-based individual insurance exchanges."

For their analysis, the authors make use of an understudied natural experiment. To make a long story short, in 2005, Tennessee discontinued the expansion of its Medicaid program (TennCare), disenrolling about 170,000 people from the program. Because the population that lost coverage with the TennCare disenrollment is relatively similar to the population that is likely to gain coverage under the ACA (more than that, TennCare was similar in some levels to the ACA, as the program also provided income-based subsidies on a sliding scale, accounting for the possibility of a marginal tax cliff), the behavior of Tennessee's labor market post-disenrollment appears to be a decent indication for what we may see under the ACA.

So what do the study's authors discover? Based on their analysis, the TennCare disenrollment resulted in a huge employment increase of about 6 percent (the authors conduct additional analysis to ensure that. Applying their results to the US as a whole, accounting for the ACA, the authors estimate a 0.3 to 0.6 percentage point decrease in employment - at a time when we quibble about 7.5 percent versus 7.6 percent unemployment, these numbers are highly significant - between 530,000 and 940,000 people.

Does this study, then, condemn the ACA as a disastrous job killer? Not quite. Certainly, the ACA's (now delayed) employer mandate will likely lead to reduced hours (involuntary part-time employment) and may reduce the total size of the workforce. But this study looks at the ACA not from the perspective of labor demand, but rather in terms of labor supply - that is, given a certain subsidy level, whether or not a person will decide to participate in the workforce. If the weakened link between employment and health insurance means that it is no longer beneficial for someone to keep working, then he will stop working. There is no implication of "welfare loss" for the individual.

And perhaps it is best to view this exit from the labor force as something of a necessary evil. If enough workers choose to drop out of the labor force because the ACA has weakened the work incentive (more precisely, it will displace the incentive coming from relatively cheap health insurance), then over the long-run, wages should rise to compensate for the diminished incentive. This could only be a good deal for workers and the economy as a whole, as workers will have higher cash wages (which would bring more revenues to government) and health care would no longer be an obstacle to switching jobs.

But more broadly, the "job lock" phenomenon (the authors are careful to call it "employment lock" because they focus on the actual decision of whether or not to participate in the labor market) presents a problem for any type of health care reform. Even more conservative reforms, such as universal HSAs, would likely result in reduced labor force participation. The problem when it comes to the ACA, however, is that many of the beneficiaries will already have high marginal tax rates as a result of other public programs - the ACA simply adds to it (though to a lesser extent than other programs).

Moreover, when it comes to the ACA, there is also a real potential for increased job lock. The employer mandate (which requires companies with more than 50 full-time equivalent employees to offer health insurance) ensures that the majority of the US will remain on employer-based plans, and those who receive newly-minted insurance through their employers (assuming they keep their hours and their jobs) will have less incentive to switch jobs. The mandate was likely included simply as a way to discourage employers from dumping workers onto the exchanges (to keep the cost of the law down); while it may do so, it also reinforces the unhealthy link between a job and health insurance.

Perhaps the best course for policymakers would be to pursue an end to tax-favored treatment of employer-sponsored health insurance. It would be an uphill battle, but ending the deduction would make concerns such as these largely moot - to much of the country's benefit.  

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