Obama's Prescription for Low-Wage Workers: High Implicit Taxes, Higher Premiums, Cato Policy Analysis No. 656

8/14/2019 Obama's Prescription for Low-Wage Workers: High Implicit Taxes, Higher Premiums, Cato Policy Analysis No. 656

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House and Senate Democrats have producedhealth care legislation whose mandates, subsidies,tax penalties, and health insurance regulationswould penalize work and reward Americans whorefuse to purchase health insurance. As a result,the legislation could trap many Americans in low-wage jobs and cause even higher health-insurancepremiums, government spending, and taxes thanare envisioned in the legislation.

Those mandates and subsidies would imposeeffective marginal tax rates on low-wage workersthat would average between 53 and 74 percentand even reach as high as 82 percentover broadranges of earned income. By comparison, thewealthiest Americans would face tax rates nohigher than 47.9 percent.

Over smaller ranges of earnedincome, the leg-islation would impose effective marginal taxrates that exceed 100 percent. Families of four

would see effective marginal tax rates as high as174 percent under the Senate bill and 159 per-cent under the House bill. Under the Senate bill,adults starting at $14,560 who earn an addition-al $560 would see their total income fall by $200due to higher taxes and reduced subsidies. Underthe House bill, families of four starting at$43,670 who earn an additional $1,100 wouldsee their total income fall by $870.

In addition,middle-incomeworkers could saveas much as $8,000 per year by dropping coverageand purchasing health insurance only when sick.Indeed, the legislation effectively removes anypenalty on such behavior by forcing insurers tosell health insurance to the uninsured at standardpremiumswhen they fall ill. The legislation wouldthus encourage adverse selectionan unstablesituation that would drive insurance premiums,government spending, and taxes even higher.

Obamas Prescription for Low-Wage WorkersHigh Implicit Taxes, Higher Premiums

by Michael F. Cannon

_____________________________________________________________________________________________________

Michael F. Cannon is director of healthpolicy studies at the Cato Institute andcoauthor of Healthy Competition:Whats Holding Back Health Care and How to Free It.

Executive Summary

No. 656 January 13, 2010


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Introduction

House and Senate Democrats have pro-duced health care legislation whose mandates,

subsidies, tax penalties, and health insuranceregulations would penalize work and reward Americans who refuse to purchase healthinsurance. As a result, the legislation couldtrap many Americans in low-wage jobs andcause evenhigher health-insurancepremiums,higher government spending, and higher tax-es than are envisioned in the legislation.

The legislation would penalize work byreducing the share of each additional dollarof income that workers would keep. Undereither bill, low- and middle-income earners

who work extra hours, accept a promotion,take a second job, or invest in education andtraining would see little benefit. Some couldeven end up worse off financially. Over time,those workers would see their taxes rise evenif their incomes remain stagnant.

Two features of the legislation would cre-ate those high implicit tax rates. First, eachbill contains an individual mandate thatwould require all Americans to purchasehealth insurance and would force low- andmiddle-income Americans to pay an increas-

ing share of their incomes toward their pre-miums as their income rises. Second, the billswould create health-insurance subsidies thatphase out as a workers income rises. As theindividual mandate imposes new, rising mar-ginal tax rates on low- and middle-incomeworkers, the phased-out subsidies would cre-ate even higher effective marginal tax rates.

Economists use the term effective mar-ginal tax rates to describe the combinedeffect that taxes and phased-out governmentsubsidies have on a workers incentive to earn

an additional dollar. High effective marginaltax rates have the same effect on work incen-tives as high statutory rates: both discourageworkers from climbing the economic ladder.The Congressional Budget Office writes:

To limit costs, subsidies are typicallyphased out as a beneficiarys income

rises. Over the phase-out range, a work-er receives less compensation for eachadditional hour worked, because eachdollar earned reduces the subsidy.1

Proposals that decreased the eco-

nomic gains from an additional hour ofwork, throughhigher taxes orthe phase-out of subsidies or credits for healthinsurance as income rises, could causesome people to work less or not at all.2

That effect, known as an implicittax, can lead people to work fewerhours than they otherwise would, inthe same way that income and payrolltax rates do. Most empirical studiesconclude that increases in marginal taxrates generally reduce the number of

hours worked, particularly among sec-ondary earners (typically, the spouse ofthe main earner in a family). Higher taxrates also reduce peoples incentive toraise their income in other ways, suchas working harder in the hope of win-ning raises; accepting new positions orresponsibilities with higher compensa-tion; or investing in their future earn-ing capacity through education, train-ing, or other means.3

For example, one study found that a seriesof increases in the income limit for Medicaideligibility in the late 1980s and 1990sincreased the labor force participation ofworking-age single mothers by 1.4 percent.4

That suggests the prospect of losing subsi-dies discouraged able-bodied individualsfrom working. Harvard economist GregoryMankiw writes, substantial evidence sup-ports the . . . proposition that high marginaltax rates discourage people from working totheir full potential.5

In addition, though the legislations pur-pose is to expand health insurance coverage,it would create large financial incentives formiddle-class Americans not to purchasehealth insurance. Although the bill containssubsidies to purchase insurance and penal-ties for Americans that do not, householdsthat choose to go uninsured could still come

2

Over time,workers would

see their taxes riseeven if their

incomes remainstagnant.


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out thousands of dollars ahead. Since the leg-islation would force insurers to sell healthinsurance to everyone at standard rates,healthy people could decline coverage, savetheir money, and purchase health insurance

only when sick. The legislation could thuslead to an adverse selection death spiralan unstable situation that would drive insur-ance premiums, government spending, andtaxes even higher.

Methods

This paper calculates the federal marginaltax rates and effective marginal tax rates thatsingle, childless adults and families of four

would face under the health care legislationapproved by theU.S. House of Representativesand the U.S. Senate. It also calculates thepenalties that those low- and middle-incomeworkers would face if they chose not to pur-chase coverage.

Information on mandate requirements,penalties, health-insurance subsidies, andcost-sharing subsidies comes from the legisla-tion.6 Estimates of the likely cost of coveragein the health insurance exchanges (uponwhich the subsidies depend) come from CBO

estimates of the likely cost of health insuranceunder each bill.7 Data on the income tax,8 pay-roll tax,9 child tax credit,10 and earned-incometax credit11 come from the Internal RevenueService.

These estimates show what full implemen-tation of the mandates, subsidies, and penal-ties would look like in 2009. Unless noted, alldollar figures use 2009 dollars. The CBOsestimates of health insurance premiums aredeflated to 2009 dollars using the averagegrowth rate of health insurance premiums

from 2004 through 2009 (6.1 percent).12

Other dollar figures are deflated to 2009 dol-lars using the projected rate of inflation from2010 through 2016 found in the CBOsEconomic Projections forCalendarYears 2009to 2019.13 Consistent with the legislation,these estimates use federal poverty thresholdsfor 2008.14

The calculations underlying these esti-mates are available on request.

A Low-Wage Trap

Both the House and Senate bills wouldimpose an individual mandate that wouldmake health insurance compulsory for nearlyall Americans. Under an individual mandate,the federal government would use its sover-eign power to compel people to purchasehealth insurance, whether they want it or not,under threat of fines and/or imprisonment.15

As a result, mandatory premium paymentsamount to a tax even though the money neverenters the federal treasury (see box).

Each bill would also create a new healthinsurance exchange (or multiple exchanges),where certain U.S. residents could purchasehealth insurance. According to the nonparti-san CBO, some 23 million Americans wouldinitially obtain health insurance through theSenate bills exchanges.16 Under both bills, thenumber of Americans who obtain insurancethrough the exchange(s) would likely growover time.17

The bills would require low- and middle-income workers to pay a specified percentage

of their adjusted gross income (AGI) towardmandatory health insurance. That specifiedpercentage would rise as a workers adjustedgross income rises. The mandate tax wouldtherefore consume an increasing share ofeach additional dollar of earnings for low-and middle-class workers, effectively increas-ing the marginal tax rates that the federalgovernment imposes on those workers.

Also within the exchanges, the legislationwould create subsidies for low- and middle-income earnersspecifically, refundable

health-insurance tax credits and cost-sharingtax creditsthat would decrease and ulti-mately disappear as household earnings rise.

The Mandate TaxEach bill would force low- and middle-

income workers to pay a specified percentageof their income toward the cost of health

3

The mandatetax wouldconsume anincreasingshare of eachadditional dollarof earnings forlow- and middleclass workers.


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insurance. The product of that mandate-taxrate and the workers adjusted gross incomedetermines each workers mandate-tax liabil-ity.25 For low- and middle-income workers,the mandate-tax rate rises as their earningsrises. It also rises with the average growthrateof health insurance premiums, independentof a workers income.

As shown in Tables 1 and 2, the House billwould require those at 133 percent of the fed-eral poverty level (FPL)about $15,000 for a

single, childless adult and $29,000 for a fam-ily of fourto pay 1.5 percent of their adjust-ed gross income toward their health insur-ance premiums. That mandate-tax ratewould rise gradually with income until itreached 12 percent for those at 400 percentFPL (about $45,000 for singles, and $87,000for families of four).

Likewise, the Senate bill would requireworkers at 100 percent FPL (about $11,000for singles and $22,000 for families of four)to pay 2 percent of adjusted gross incometoward the cost of their coverage. The man-date-tax rate would then rise with incomeuntil it reached 9.8 percent for workers at 300percent FPL. It would then remain at 9.8 per-cent until adjusted gross income reaches 400percent FPL. Above 400 percent FPL, workerswould be responsible for 100 percent of their

premiums.The actual marginal tax rates that result,

however, would exceed those statutory man-date-tax rates. Each bill would apply its risingmandate-tax rates not just to income above acertain threshold, butto every single dollar ofadjusted gross income. That is, the billswould apply rising marginal tax rates not just

4

The Houseand Senate

bills violate the

universallyaccepted principlethat marginal taxrates should only

apply to incomeat the margin.

Is the Individual Mandate a Tax?

President Obama argues that a legal requirement for individuals to purchase healthinsurance is not a tax.18 Yet many economists, including some of President Obamas

economic advisers, consider it to be a type of tax.Princeton University health economist Uwe Reinhardt writes, [Just because] the fis-cal flows triggered by [the] mandate would not flow directly through the public bud-gets does not detract from the measures status of abona fide tax.19

MIT health economist Jonathan Gruber writes, Suppose . . . the government man-dated that everyone buy full insurance at the average price. . . . This would not be a veryattractive plan to careful consumers . . . who could view themselves as essentially beingtaxed in order to support this market, by paying higher premiums than they shouldbased on their risk.20

President Obamas National Economic Council chairman Larry Summers writes,Essentially, mandated benefits are like public programs financed by benefit taxes.21

Sherry Glied, President Obamas appointee to assistant secretary for planning and

evaluation at the Department of Health and Human Services, writes, The individualmandate . . . is in many respects analogous to a tax. It requires people to make paymentsfor something whether they want it or not.22

When the Clinton administration proposed an individual mandate in 1993, theCBO went so far as to treat the mandatory premiums that Americans would pay as fed-eral revenues and include them in the federal budget.23 So far, the CBO has not donethe same for the mandates in the House and Senate bills. (As Reinhardt suggests, thatdoes not imply that those mandates are not a tax.)

Each bill would also impose penalties on individuals (and employers) who do notcomply with the health-insurance mandates. Those penalties would be paid to theInternal Revenue Service along with ones income taxes.24


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to the marginal dollar, but to everyinfra-mar-ginal dollar as well. The House and Senatebills thus violate the universally acceptedprinciple of taxation that marginal tax ratesshould only apply to income at the margin.

To illustrate, under current law, the feder-al income tax rate rises from 10 percent to 15

percent once a single filers taxable incomeexceeds $8,350.26 If taxable income is $8,400,then the first $8,350 is taxed at the 10-per-cent rate (tax: $835), and the marginal $50 istaxed at the 15-percent rate (tax: $7.50), for atotal tax liability of $842.50. If the income taxwere to operate like the Democrats mandatetax, then earning $50 above the threshold

would subject all $8,400not just the mar-ginal $50to the 15-percent rate. That mar-ginal $50 would therefore cause the workerstax liability to jump not by $7.50, but by$425.27 The actual marginal tax rate appliedto that $50 would not be 15 percent, but 850percent. In the same manner, the House and

Senate bills would create marginal tax ratesthat exceed the statutory mandate-tax rates.

Each bill would therefore impose a newmandate tax, with hidden rising marginal taxrates, on low- and middle-income workers.Table 1 shows the range of marginal tax ratesthat the bills would impose on low- and mid-dle-income single adults. Table 2 shows the

5

Table 1

Explicit and Implicit Tax Rates for Single, Childless Adults

Marginal Effective Max. Annual

Federal Mandate-Tax Effective Marginal Savings from

Poverty Income Statutory Rates Marginal Tax Rates Dropping

Level Range Mandate-Tax (5% FPL Tax Rate (5% FPL Coverage

Range (2009)* Rates increments) (Average) increments) (2009)**

House bill 133% $15,000 1.5%12% 10%20% 59% 28%110% $2,600

(H.R. 3962) 400% $45,000

Senate 100% $11,000 2%9.8% 2%53% 53% 25%125% $2,900

(H.R. 3590) 400% $45,000

*Dollar figures rounded to the nearest thousand.

**Dollar figures rounded to the nearest hundred.

Table 2

Explicit and Implicit Tax Rates for Families of Four

Marginal Effective Max. Annual

Federal Mandate-Tax Effective Marginal Savings from

Poverty Income Statutory Rates Marginal Tax Rates Dropping

Level Range Mandate-Tax (5% FPL Tax Rate (5% FPL Coverage

Range (2009)* Rates increments) (Average) increments) (2009)**

House bill 133% $29,000 1.5%12% 10%20% 74% 37%159% $7,800

(H.R. 3962) 400% $87,000

Senate 100% $22,000 2%9.8% 2%53% 62% 37%174% $8,000

(H.R. 3590) 400% $87,000

*Dollar figures rounded to the nearest thousand.

**Dollar figures rounded to the nearest hundred.


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same data for families of four. The House billwould create new marginal tax rates thatwould reach as highas 20 percent for both sin-gles andfamilies offour.TheSenate bill wouldimpose marginal tax rates as high as 53 per-

cent for both singles and families of four.

28

Tables 1 and 2 showthe marginal tax ratesthat the bills would create in their first year ofimplementation. Under both bills, thosemarginal tax rates would rise automaticallyover time. After the first full year of imple-mentation, the mandate-tax rates wouldgrow at the same rate as health insurance pre-miums, independent of workers incomes.29

Since health insurance premiums tend togrow faster than wages or inflation, middle-class workers could see their tax rates rise

even if theirreal incomes were to remain stag-nant or fall.

Phased-Out SubsidiesWithin the exchanges, the bills would also

create means-tested subsidies whose with-drawal, when combined with the mandate tax,would impose even higher effective marginaltax rates. The bills would create two types ofsubsidy that would contribute to this effect.

The first is a subsidy called a premium taxcredit. The amount that low- and middle-

income workers would have to pay towardtheir health insurance premiums would gen-erally be less than the full premium. To makeup the difference, each bill would create pre-mium tax credits. The amount of these creditswould be the difference between a specifiedreference premium and the workers man-date-tax liability:

Health-Insurance Tax Credit = (ReferencePremium) (Mandate-Tax Liability)

The tax credits therefore phase out as incomerises; that is, as ones mandate-tax liabilityapproaches the reference premium.30

The bills would also create subsidies calledcost-sharing tax credits. These subsidieswould increase the comprehensiveness of aneligible households health plan to a specifiedactuarial value. Those actuarial values are

higher for low-income households and fall if ahouseholds earningsrise. (Calculatingthe val-ue of the cost-sharing subsidies is thus similarto calculating the value of the health-insur-ance tax credits.) The value of these subsidies

falls abruptly when a workers adjusted grossincome passes certain thresholds. That createsa cliff effect, where a small increase in earn-ings leads to a large decrease in total income.

A Steep Climb out of PovertyThe following estimates incorporate the

effects of federal payroll taxes, income taxes,thechild tax credit, andtheearned-income taxcredit to reveal the effective marginal tax ratesthat the House and Senate health care billswould impose on low- and middle-income

workers enrolled in the health insuranceexchange(s). Effective marginal tax rateswould vary depending on a households start-ing income and the amount of additionalincome earned (i.e., the size of the margin)Thus, Figures 1 through 4 offer different waysof portraying how the bills would affect workincentives.

Figures 1 and 2 show the overall or averageeffective marginal tax rates that low-wageworkers would face over a broad range of earn-ings. Figure 1 shows that under the House bill,

single adults starting at $15,000 per yearwould face an average effective marginal taxrate of about 59 percent as they work towardincreasing their earnings to $45,000. That is,they would keep about 41 cents out of eachadditional dollar earned along the way, andwould lose the remainder to higher taxes andforgone subsidies. If they increased their earn-ings to $34,000, however, their average effec-tive marginal tax rate would be 65 percentthat is, their total income would only rise byabout $1 forevery additional $3 earned. Under

the Senate bill, single adults starting at$11,000 would face an average effective mar-ginal tax rate of 53 percent. Until they pass$45,000 of earnings, their total income wouldhave risen just 47 cents for each additionaldollar of earned income. Their average effec-tive marginal tax rate could also rise as high as66 percent. (See Figure 1.)

6

Workers could seetheir tax rates rise

even if their realincomes were to

remain stagnantor fall.


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7

Figure 1

Overall or Average Effective Marginal Tax Rates for Single, Childless Adults Who

Start at $12,000 (100% FPL) under the Senate Bill or $15,000 (133% FPL) under the

House Bill

Figure 2

Overall or Average Effective Marginal Tax Rates for Families of Four Who Start at

$23,000 (100% FPL) under the Senate bill or $31,000 (133% FPL) under the House bill

Adjusted Gross Income (2009 dollars)



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Effective marginal tax rates would be evenhigher for families of four. The House billwould impose an average effective marginaltax rate of 74 percent on families of four start-ing at $29,000 per year. On average, their total

income would have risen just 26 cents for eachadditional dollar of earned income, untilearned income reached about $90,000 peryear. Again, their average effectivemarginaltaxrate would often be higher. A family of fourthat struggled to climb from $30,000 to$45,000 would get to keep less than $3,000 ofthat additional $15,000 earned; their implicittax rate would exceed 80 percent. Under theSenate bill, families of four starting at $22,000would face average effective marginal tax ratesof 62 percent, letting them keep just 38 cents

of each additional dollar of earnings. If theyincreased their earnings to about $45,000,their average effective marginal tax rate wouldbe 73 percent. (See Figure 2.)

People often face opportunities to increasetheir earnings by smaller amounts. Figures 3and 4 therefore depict the effective marginal

tax rates that would apply to smaller changesin earned income.

Figure 3 presents effective marginal taxrates forsingle adultsat any given earnings lev-el who increase their earnings by an amount

equal to 5 percent of the federal poverty level,or roughly $560. Single adults who earn anadditional $560say, by working extrahourscould face effective marginal tax ratesas high as 110 percent under the House billand 125 percent under the Senate bill. Forexample, under the Senate bill, adults with anannual income of $14,560 who earn an addi-tional $560 would see their total income fallby $200. They would thus be financially betteroff not having worked the extra hours. Underthe House bill, adults with $22,400 of income

who earn another $560 would see their totalincome fall by $143. At present, single adultsin this earnings range face effective marginaltax rates no higher than 38 percent.

Similarly, Figure 4 shows the effective mar-ginal tax rates for families of four, at any givenearnings level,whoincrease theirearnings by 5

8

Single adultswho earn an

additional$560 could face

effective marginaltax rates as high

as 110 percentunder the

House bill and125 percent under

the Senate bill.


Figure 3

Effective Marginal Tax Rates for Single, Childless Adults at Any Initial Earned

Income, Who Increase Earnings by $560 (5% FPL)


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percent of the federal poverty level (roughly

$1,100). Families of four would see effectivemarginal tax rates as high as 159 percentunder the House bill and 174 percent underthe Senate bill. Under the Senate bill, familiesof four starting at $28,380 who earn another$1,100 would see their total income fall by$450. Under the House bill, families of fourstarting at $43,670 who earn an additional$1,100 would see their total income fall by$870, leaving them worse off financially.

Under current federal tax law, effectivemarginal tax rates do not reach even 50 per-

cent for families of four in this income range.Even the wealthiest Americans would notface effective marginal tax rates as high asthose that the Democrats health care billswould impose on low- and middle-incomeearners. Under the House bill, the wealthiestAmericans would face a marginal tax rate ofjust 47.9 percent.31

Caveats

These estimates do not include the effectsthat state income taxes and other means-test-ed government subsidies would have on tar-geted workers. Insofar as such policies exist,these estimates understate the effective mar-ginal tax rates that low- and middle-incomeworkers would face under the House andSenate legislation. For example, within therange of income examined here, many statesimpose marginal income-tax rates of 5 per-cent or more. Californians with incomes inthis range could paya marginal state income-

tax rate of 6.25 percent or even 8.25 percent.The Senate bill contains provisions intend-

ed to dampen those work disincentives.32 TheIRS would determine a workers mandate-taxrate based on what she reports her householdincome will be in the coming year. If house-hold income is higher than expected, the IRSwould require her to pay more toward her

9

Families offour would seeeffective marginatax rates as highas 159 percentunder theHouse bill and174 percent undethe Senate bill.

Figure 4

Effective Marginal Tax Rates for Families of Four at Any Initial Earned Income, Who

Increase Earnings by $1,100 (5% FPL)



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health insurance premiumsbut still not asmuch as she would have been expected to payhad the income prediction been accurate.Such provisions can temporarily mitigate, butthey cannot eliminate, the work disincentives

created by the mandate tax and the phased-out subsidies. To the extent that they do miti-gate those work disincentives, those provi-sions add to the cost of the legislation. TheCBO explains:

Policymakers face a trade-off in decid-ing how to phase out subsidies. If sub-sidies are large and are phased outquickly, the implicit tax rates, and thusthe negative impact on work incen-tives, can be quite high. Implicit tax

rates can be reduced by expanding therange over which the subsidy is phasedout, but doing so increases the numberof people subject to the implicit taxand boosts the total cost of the sub-sidy. In the extreme, the same subsidycan be granted to everyone, but doingso substantially increases budgetarycosts, which might in turn be financedthrough higher explicit tax rates.33

The high effective marginal tax rates that

the House and Senate legislation would createcannotbe fixedwitha quick amendment.Theyare an inherent part of the bills strategy ofexpanding coverage by shifting costs to taxpay-ers, rather than by reducing costs throughgreater efficiency.34 The only way to expandcoverage while avoiding both those perverseincentives and the alternative exorbitant costsis to abandon the bills strategy of robbingPeter to pay Paul, and instead reduce the costof care through innovation and competition.35

Incentives to Drop Coverage

The bills likewise would create perverseincentives for exchange-eligible workers not topurchase health insurance at all. Each billwould impose both a guaranteed issue re-quirement and community rating price con-

trols on insurers.36 Guaranteed issue requiresinsurers to issue policies to all applicantswhile community rating prohibits insurersfrom setting premiums according to an applicants health status. In combination, guaran-

teed issue and community rating enable con-sumers to avoid health insurance until theyare sick, and then buy coverage from anyinsurer at standard premiums.

Penalties for NoncomplianceTo mitigate such behavior, the legislation

would impose explicit tax penalties on Ameri-cans who do not purchase health insurance.The House bill would require uninsuredwork-ers to pay a tax penalty equal to 2.5 percent ofadjusted gross income.37 The Senate bill would

impose either a flat penalty (which wouldreach $750 per noncompliant adult in 2016;the penalty for each uninsured child would behalfthe penalty for adults)ora penalty equal to2 percent of taxable income. The Senate billwould waive any penalties if the cost of healthinsurance premiums exceeded 8 percent of in-come.38

Even with those penalties, many Americanswould still find it profitable to wait until theywere sick to purchase health insurance.39

Under the House bill, singles earning more

than $16,000 per year and families of fourearning more than $32,000 per year wouldbenefit financially from dropping coveragepaying the penalty, and waiting until they aresick to purchase coverage. Singles could saveup to $2,600 per year, while families of fourcould save nearly $7,800 per year. Under theSenate bill, singles earning more than $16,000peryearand families offourearningmorethan$38,000 per year would face similar incentivesSingles could save as much as $2,900. Familiesof four could save$8,000. (See Figures5 and 6.)

Many describe young adults who choosenot to purchase health insurance as younginvincibles who believe they will never needmedical care.40Yet the House and Senate legislation could create cadres of middle-ageinvincibles and of-a-certain-age invincibleswho would only purchase insurance whenthey fall ill.

10

Under theSenate bill,

singles could saveup to $2,900

per year, whilefamilies of four

could save $8,000per year by

droppingcoverage.


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11


Figure 6

Annual Savings from Dropping Coverage, Families of Four


Figure 5

Annual Savings from Dropping Coverage, Single, Childless Adults


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Higher Premiums, Higher TaxesThe perverse financial incentives to drop

coverage would destabilize health insurancemarkets, leading to higher premiums, highertaxes, and additional government spending.

The people most likely to respond to theincentives to drop coverage are healthier-than-average Americans.41 As healthy individualsopt out of health insurance pools, those poolswill become older and sicker. Actuaries callthis adverse selection: the people who self-select into insurance pools are sicker thanaverage, which has an adverse effect on premi-ums. Those rising premiums spur additionalhealthy enrolleesto drop their coverage, whichcauses premiums to climb further. Absentsome intervening factor, the result is an

adverse selection death spiral.As premiums climb higher, insured voters

will predictably demand that politicians stophealthy people from gaming the system.Politicians will predictably respond by increas-ing the tax penalties for the uninsured andincreasing subsidies to the insured, whichwould require additional tax increases. Thepotential for additional taxes and governmentspending suggests that the bills actual costswould exceed its projected costs.

Conclusion

The health care bills that President BarackObama is shepherding through Congress con-tain new taxes and new government subsidies,both of which would touch low- and middle-income Americans. The complexity of thosetax-and-subsidy schemes makes it difficult forvoters to discern whether they would be a netbeneficiary or a net payer.That opacity may bedeliberate.42

Yet supporters of President Obamashealth care legislation cannot mask the realitythat low- and middle-income exchange partic-ipants would face often alarmingly high effec-tive marginal tax rates. Even if such workerswould receive subsidies under the House orSenate bill, they nevertheless would keep lessof every additional dollar of income than they

do today. Many would see their tax bills riseeven as their real incomes fell. Those perverseincentives would set a low-wage trap for mil-lions of Americans, discouraging them fromclimbing the economic ladder and encourag-

ing them to remain dependent on taxpayers.Meanwhile, the legislations insurance regula-tions would encourage Americans notto pur-chase coveragethe opposite of the legislations intended effect.

Real health care reform would not dis-courage Americans from purchasing healthinsurance, discourage low-income workersfrom climbing the economic ladder, or createan unstable environment that would lead tohigher premiums, more government spend-ing, and higher taxes.

NotesThe author would like to thank Victoria Payne forher invaluable assistance.

1. U.S. Congressional Budget Office (CBO), Ef-fects of Changes to theHealthInsuranceSystemonLabor Markets, CBO Economic and Budget IssueBrief, July 13, 2009, pp. 56, http://www.cbo.gov

/ftpdocs/104xx/doc10435/07-13-HealthCareAndLaborMarkets.pdf.

2. CBO, Key Issues in Analyzing Major Health Insur-

ance Proposals, December 2008, p. 155, http://www.cbo.gov/ftpdocs/99xx/doc9924/12-18-KeyIssues.pdf.

3. CBO, Effects of Changes to the Health Insur-ance System on Labor Markets, pp. 56.

4. CBO, Key Issues in Analyzing Major Health Insur-ance Proposals, p. 163.

5. Gregory Mankiw, Supply-Side Ideas, TurnedUpside Down,NewYork Times, October 31, 2009http://www.nytimes.com/2009/11/01/business/economy/01view.html.

6. SeeH.R. 3962,Affordable Health Care for Amer-ica Act, 111th Cong., 1st sess., passedthe House onNovember 7, 2009, http://docs.house.gov/rules/health/111_ahcaa.pdf; and the Patient Protectionand Affordable Care Act (Senate bill), an amend-ment in the nature of a substitute to H.R. 3590,111th Cong., 1st sess., introduced November 19,2009, http://democrats.senate.gov/reform/patient-protection-affordable-care-act.pdf, as modified bythe Managers Amendment no. 3276 to the Reid

12

The Obama planwould set a

low-wage trapfor millions and

encourageAmericans not

to purchasecoveragethe

opposite of the

legislationsintended effect.


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Substitute Amendment no. 2786, http://democrats.senate.gov/reform/managers-amendment.pdf.

7. The CBO estimates that under the House pro-posal, the average premium for a self-only healthplan with an actuarial value of 70 percent (a sil-

ver plan) would be $5,300 in 2016. A similar fam-

ily plan would cost $15,000. CBO, letter to theHon. Charles B. Rangel, November 2, 2009, p. 4,http://www.cbo.gov/ftpdocs/106xx/doc10691/hr3962SubsidiesRangelLtr.pdf. The agencyestimates that under the Senate bill, similar planswould cost $5,200 for singles and $14,100 forfamilies. CBO, letter to the Hon. Evan Bayh, No-

vember 30, 2009, p. 6, http://cbo.gov/ftpdocs/107xx/doc10781/11-30-Premiums.pdf.

8. Internal Revenue Service, 1040Instructions 2009,pp. 7788, http://www.irs.gov/pub/irs-pdf/i1040gi.pdf.

9. Internal Revenue Code of 1986, Sections 3101

(employee portion) and 3111 (employer portion),http://www.ssa.gov/OP_Home/comp2/F083-591.html.

10. Internal Revenue Service, pp. 4344.

11. Internal Revenue Service, pp. 5271.

12. Drew Altman, Pulling It Together . . . SimpleArithmetic, Kaiser Family Foundation, Septem-ber 15, 2009,http://www.kff.org/pullingittogether/091509_altman.cfm.

13. CBO, CBOs Economic Projections for Cal-endar Years 2009 to 2019, http://www.cbo.gov/ftpdocs/100xx/doc10014/econproj.xls.

14. For a single, childless adult under 65 years ofage, the 2008 federal poverty threshold was$11,201. For a family of four with two children, itwas $21,834. See U.S. Bureau of the Census,Poverty Thresholds for 2008 by Size of Familyand Number of Related Children under 18 Years,last modified September 29, 2009, http://wwwcensus.gov/hhes/www/poverty/threshld/thresh08.html.

15. In 1994, the CBO wrote, The imposition of

an individual mandate . . . would be an unprece-dented form of federal action. CBO, The Budg-etary Treatment of an Individual Mandate to BuyHealth Insurance, CBO Memorandum, August1994, p. 1, http://www.cbo.gov/ftpdocs/48xx/doc4816/doc38.pdf. In the past, the agency has de-scribed proposed mandates as an exercise of sov-ereign power. CBO, An Analysis of the Admin-istrations Health Proposal, February 1994, p. xv,http://www.cbo.gov/ftpdocs/48xx/doc4882/doc

07.pdf. See also, Carrie Budoff Brown, EnsignReceives Handwritten Confirmation, PoliticoLive Pulse, September 25, 2009, http://www.politico.com/livepulse/0909/Ensign_receives_handwritten_confirmation_.html. (Sen. John Ensign(R-Nev.) received a handwritten note Thursdayfrom Joint Committee on Taxation Chief of Staff

Tom Barthold confirming the penalty for failingto pay the up to $1,900 fee for not buying healthinsurance. Violators could be charged with a mis-demeanor and could face up to a year in jail or a$25,000 penalty, Barthold wrote on JCT letter-head.)

16. CBO, letter to the Hon. Evan Bayh, November30, 2009, p. 24, http://cbo.gov/ftpdocs/107xx/doc10781/11-30-Premiums.pdf.

17. See CBO, letter to the Hon. Charles B. Rangel,October 29, 2009, http://cbo.gov/ftpdocs/106

xx/doc10688/hr3962Rangel.pdf. (CBO and JCTnow estimate that the federal administrator over-seeing the insurance exchanges might well allowmedium-sized and large firms to purchase cover-age through the exchanges.) See also, CBO, letterto the Hon. Evan Bayh, November 30, 2009, p. 13.(In 2016, states would have to give all employerswith 100 or fewer employees the option to pur-chase coverage through the exchanges. Statescould give larger employers that option startingin 2017.)

18. George Stephanopoulos, Obama: Mandate IsNot a Tax, Georges Bottom Line, September 20,2009, http://blogs.abcnews.com/george/2009/09/obama-mandate-is-not-a-tax.html.

19. Uwe Reinhardt, Should All Employers BeRequired by Law to Provide Basic Health Insur-ance Coverage for Their Employees and Depen-dents?, in Government Mandating of Employee

Benefits (Washington: Employee Benefits ResearchInstitute, 1987); quoted in Lawrence Summers,Some Simple Economics of Mandated Benefits,

American Economic Review 79, no. 2 (May 1989):17783, http://bit.ly/3FZFg8.

20. Jonathan Gruber,Public Finance and Public Policy(New York: Worth, 2005), p. 314, http://bit.ly/4rahcn. One could argue that it is the price controls,rather than the mandate, that Gruber likens to a

tax. Yet the price controls merely increase the pre-miums that low-risk consumers face. They do notforce consumers to pay those premiums; the man-date does that. It might be inconsistent, moreover,to suggest that when price controls force you topay more for something than the market wouldcharge, that is a tax, butwhen a mandate forces youto purchase something you dont want at all, thatis not a tax.

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21. Summers, pp. 17783.

22. Sherry A. Glied, Universal Coverage OneHead at a TimeThe Risks and Benefits of In-dividual Health Insurance Mandates, New Eng-land Journal of Medicine 358, no. 15 (April 10,2008): 154042, http://bit.ly/1kLGbN.

23. See CBO, An Analysis of the AdministrationsHealth Proposal, February 1994, p. xv. See also,CBO, The Budgetary Treatment of Proposals toChange the Nations Health Insurance System,Economic and Budget Issue Brief, May 27, 2009,http://cbo.gov/ftpdocs/102xx/doc10243/05-27-HealthInsuranceProposals.pdf.

24. See Patient Protection and Affordable CareAct (Senate bill), p. 325.

25. The bills use a modified definition of adjustedgross income, which does not affect this papersestimates.

26. Threshold is for 2009. Tax Foundation, U.S.Federal Individual Income Tax Rates History,19132009, January 2, 2009, http://www.taxfoundation.org/publications/show/151.html.

27. (0.15) x ($8,400) - (0.1) x ($8,350) = ($1,260) ($835) = $425.

28. These marginal tax rates are sensitive to thesize of the margin. The margin used here is 5 per-cent of the federal poverty level. See also Figures 1and 2.

29. See H.R. 3962; and the Patient Protectionand Affordable Care Act (Senate bill), p. 241.

30. In most cases, the phase-out of the premiumtaxcredit does not have any additional impact on aworkers effective marginal tax rate; the effect iscapturedby the mandate tax, with one exception. Aworkers marginal mandate-tax rate falls to zeroonce her mandate-tax liability reaches the value ofthe minimum benefits package the legislationwould require her to purchase. That is, the legisla-tion would not require her to devote any addition-al income to health insurance. However, if sheincreases her income but does not purchase anyadditional coverage, her premium tax credit falls to

zero. That loss of the premium tax credit doesinfluence her effective marginal tax rate.

31. Tax Foundation, If Health Surtax Is 5.4 Per-cent, Taxpayers in 39 States Would Pay a Top TaxRate over 50%, Fiscal Fact no. 178, July 14, 2009,http://www.taxfoundation.org/publications/show/24863.html.

32. See Patient Protection and Affordable CareAct (Senate bill), p. 255.

33. CBO, Effects of Changes to the Health In-surance System on Labor Markets, p. 6.

34. See generally, Victor Fuchs, Cost ShiftingDoes Not Reducethe Cost of Health Care,Journaof the American Medical Association 302, no. 9(September 2, 2009): 999-1000, http://jama.ama-

assn.org/cgi/content/short/302/9/999. (Almostevery political pronouncement now emphasizescost reduction as a central object of health carereform. The policy recommendations that followhowever, frequently aim at cost shifting ratherthan cost reduction. . . . To see the irrelevance ofshifting for cost reduction, consider the proposalto prohibit health insurancecompanies fromvarying premiums according to enrollees health sta-tus. This obviously reduces premiums for the sickbut, not so obviously, also increases premiums forthe healthy. Such a shift . . . does nothing to reducethe real costof care. . . . A subsidy isanother exam-ple of a so-called cut in the cost of care, but also is

just cost shifting. A subsidy reduces the cost for

low-income eligible individuals by shifting thecost to higher-income taxpayers.)

35. See Michael F. Cannon, Yes, Mr. President, aFree Market Can Fix Health Care, Cato InstitutePolicy Analysis no. 650, October 21, 2009, http:

//www.cato.org/pubs/pas/pa650.pdf.

36. See Aaron Yelowitz, ObamaCare: A Bad Dealfor Young Adults? Cato Institute Briefing Paperno. 115, November 5, 2009, http://www.cato.org/pubs/bp/bp115.pdf.

37. H.R. 3962, p. 297, http://docs.house.gov/rules /health/111_ahcaa.pdf. The House bill wouldalso impose an 8-percent payroll tax penalty onemployers who do not comply with that billsemployer mandate. H.R. 3962, p. 275. Since em-ployers finance such levies by reducing wages, ineffect, the House bill would additionally impose a10.5-percent payroll tax on uninsured adults whowork for noncompliant employers.

38. Patient Protection and Affordable Care Act(Senate bill), p. 326.

39. The CBO writes that the Senate bill wouldestablish an annual open enrollment period fornew nongroup policies . . .which would limit op-

portunities for people who are healthy to waituntil an illness or other health problem arosebefore enrolling. CBO, letter to the Hon. EvanBayh, November 30, 2009, p. 19. EconomistMartin Feldstein posits that short-term insurancepolicies would emerge to cover medical expensesthat arise between the onset of need and the pur-chase of health insurance. Martin FeldsteinObamacares Nasty Surprise, Washington PostNovember 6, 2009, http://www.washingtonpostcom/wp-dyn/content/article/2009/11/05/AR20

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09110504327.html.

40. See Yelowitz.

41. See Yelowitz.

42. See Nobel laureate James M. Buchanans re-

statement of Italian economist Amilcare Puvianisfiscal illusion hypothesis: The ruling groupattempts, to theextent that is possible, to create fis-cal illusions, and these have the effect of making

taxpayers think that the taxes to which they aresubjected are less burdensome than they actuallyare. At the same time, other illusions are createdthat make beneficiaries consider the values of pub-lic goods and services provided them to be largerthan may actually be the case. The various institu-tions of taxing and spending are so organized as to

create this set of illusions. James M. Buchanan,Collected Works of James M. Buchanan, Vol. 4Public Finance in Democratic Process: Fiscal Institutions andIndividual Choice(Indianapolis: LibertyFund, 1999),

15

STUDIES IN THE POLICY ANALYSIS SERIES

655. Three Decades of Politics and Failed Policies at HUD by Tad DeHaven(November 23, 2009)

654. Bending the Productivity Curve: Why America Leads the World in MedicalInnovation by Glen Whitman and Raymond Raad (November 18, 2009)

653. The Myth of the Compact City: Why Compact Development Is Not the Wayto Reduce Carbon Dioxide Emissions by Randal OToole (November 18, 2009)

652. Attack of the Utility Monsters: The New Threats to Free Speech by JasonKuznicki (November 16, 2009)

651. Fairness 2.0: Media Content Regulation in the 21st Century by RobertCorn-Revere (November 10, 2009)

650. Yes, Mr President: A Free Market Can Fix Health Care by Michael F.Cannon (October 21, 2009)

649. Somalia, Redux: A More Hands-Off Approach by David Axe (October 12,2009)

648. Would a Stricter Fed Policy and Financial Regulation Have Averted theFinancial Crisis? by Jagadeesh Gokhale and Peter Van Doren (October 8, 2009)

647. Why Sustainability Standards for Biofuel Production Make LittleEconomic Sense by Harry de Gorter and David R. Just (October 7, 2009)

646. How Urban Planners Caused the Housing Bubble by Randal OToole(October 1, 2009)


16/16

645. Vallejo Con Dios: Why Public Sector Unionism Is a Bad Deal forTaxpayers and Representative Government by Don Bellante, DavidDenholm, and Ivan Osorio (September 28, 2009)

644. Getting What You Paid ForPaying For What You Get: Proposals for the

Next Transportation Reauthorization by Randal OToole (September 15, 2009)

643. Halfway to Where? Answering the Key Questions of Health Care Reformby Michael Tanner (September 9, 2009)

642. Fannie Med? Why a Public Option Is Hazardous to Your Health byMichael F. Cannon (July 27, 2009)

641. The Poverty of Preschool Promises: Saving Children and Money with theEarly Education Tax Credit by Adam B. Schaeffer (August 3, 2009)

640. Thinking Clearly about Economic Inequalityby Will Wilkinson (July 14,2009)

639. Broadcast Localism and the Lessons of the Fairness Doctrine by JohnSamples (May 27, 2009)

638. Obamacare to Come: Seven Bad Ideas for Health Care Reformby Michael Tanner (May 21, 2009)

637. Bright Lines and Bailouts: To Bail or Not To Bail, That Is the Question

by Vern McKinley and Gary Gegenheimer (April 21, 2009)

636. Pakistan and the Future of U.S. Policyby Malou Innocent (April 13, 2009)

635. NATO at 60: A Hollow Alliance by Ted Galen Carpenter (March 30, 2009)

634. Financial Crisis and Public Policyby Jagadeesh Gokhale (March 23, 2009)

633. Health-Status Insurance: How Markets Can Provide Health Securityby John H. Cochrane (February 18, 2009)

632. A Better Way to Generate and Use Comparative-Effectiveness Researchby Michael F. Cannon (February 6, 2009)

631. Troubled Neighbor: Mexicos Drug Violence Poses a Threat to theUnited States by Ted Galen Carpenter (February 2, 2009)

Documents

Obama's Prescription for Low-Wage Workers: High Implicit Taxes, Higher Premiums, Cato Policy Analysis No. 656