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The ACA’s Unintended Consequences

eye on the news

The ACA’s Unintended Consequences

Obamacare will depress wages and productivity. May 14, 2015
Photo by Joe Raedle/Getty Images

As a Supreme Court decision looms next month in King v. Burwell, which could determine the future of Obamacare, much of the economic discussion surrounding the Affordable Care Act (ACA) focuses, understandably, on the law’s effects on insurance premiums and on the delivery of health care. But the ACA also has significant potential to affect the allocation of labor—and thus wages—throughout the U.S. economy, through its penalties for employers that don’t provide health insurance for their workers as well as through its subsidies for individuals to purchase health insurance (the latter of which is the subject of the King case). The employer penalties and the individual subsidies will exert a downward effect on average wages and on wage patterns, across industry sectors and income levels. And because the law privileges certain kinds of businesses over others, it will also reduce productivity.

One way to understand this is through Adam Smith’s theory of equalizing differences, through which we can trace and quantify the effects of the employer penalty and the exchange subsidies on wages and productivity. Doing so, I found that, overall, the ACA will reduce wages by $1,000 per year—or about 4 percent of wages for workers from low-income families and nearly 2 percent of wages for workers from higher-income families. Quite distinct from the ACA’s impact on insurance availability and on the quality of health care, these effects should be better understood.

To help the uninsured get health-insurance coverage, the ACA created what it calls “health-insurance exchanges,” the collection of policies offered to each state’s residents by private insurance companies, subject to state and federal regulations regarding standardization of policy benefits, provisions, and pricing. Many, but not all, individuals shop on the exchanges by visiting a website that gathers customer information and quotes prices. Most people getting insurance through the exchanges receive financial assistance in up to two ways: reduced insurance premiums (administered through an income-tax credit system) or reduced out-of-pocket health costs, such as co-payments and deductibles. I collectively refer to the two subsidies as “exchange subsidies.”

Because exchange subsidies are available only to persons not eligible for affordable employer coverage, the ACA requires that large employers either provide affordable coverage or pay a penalty, computed according to how many full-time employees they have. The law defines a large employer as one with at least 50 full-time-equivalent employees in the calendar year prior to the one in which it failed to provide coverage. (Part-time employees count toward full-time equivalents in proportion to their hours worked.) Unlike employee wages, the penalty is not deductible for the purpose of determining the employer’s business-income tax—and this fact, together with the law’s procedure for indexing the penalty to health-cost inflation, means that the employer penalty in 2016 (the first year in which it will be fully enforced) would be as costly as $3,163 per employee on the full-time payroll beyond 30 employees.

Because the cost of the penalty to their employer could cause a reduction in wages or even the loss of their jobs, workers at penalized employers would appear, at first glance, to be losers here. However, as workers leave penalized employers and compete for jobs at employers that do offer coverage (hereafter “ESI employers,” for “employer-sponsored insurance”), they drive down wages at these employers and mitigate some of the penalty’s effect on wages at employers that don’t offer coverage (hereafter, “non-ESI employers”). It would work something like this: among groups of workers earning roughly the same amount, the ACA penalty takes part of the pay of the non-ESI (i.e., penalized) sector. Employees leave the penalized sector to take advantage of the higher ESI-sector pay. The more employees who seek work in the ESI sector, the less ESI employers need to pay for them. At the same time, the more employees who leave the penalized sector, the more the penalized employers are willing to pay the employees who remain. Non-ESI employees, then, will be partially compensated for the penalty-free opportunities existing outside their sector. The newly depressed pay among ESI employees amounts to a hidden tax on these workers: the employer penalty reduces their pay, even though their employers don’t pay it. In effect, penalized employees escape part of their penalty by passing it on to ESI employees.

Here is how the father of economics, Adam Smith, explained such a dynamic: “If . . . there was any employment evidently either more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert it in the other [think “employer penalty”], that its advantages would soon return to the level of other employments.”

The wage cut for ESI employees is known in the economics trade as a “compensating” or “equalizing” difference. In effect, all workers pay part of the employer penalty, even when their employer is not penalized. The effect of the employer penalty on employee pay increases with the size of the penalty itself, but it also depends on the size of the non-ESI sector. The larger the non-ESI sector, the more that ESI wages will have to fall in order to absorb workers leaving the sector. A helpful estimate of the amount that the penalty depresses overall wages is the product of the penalty and the non-ESI share of the labor market. In other words, the larger the penalty, or the larger the number of workers at penalized employers, the greater the wage effect.

Table 1 shows three estimates, one in each column. The first column pertains to workers in relatively low-income families—those at or below three times the federal poverty line (FPL). The second column pertains to workers in moderate- to high-income families, and the final column summarizes all workers.

Table 1. The wage impact of the 2016 employer penalty, assuming no productivity loss

The table’s top row shows the size of the penalty, which is the salary equivalent of $3,163, regardless of family income. The second row shows the fraction of workers who work full-time for an employer that doesn’t offer coverage and will be penalized if expanding beyond 49 employees. For low-income workers, that fraction is 0.22, or 22 percent of all employment by low-income workers.

The last row, in bold, shows the penalty’s overall wage impact: $683 per year on low-income workers and $510 on moderate- to high-income workers. For all workers, the penalty impact averages $577 per year. The bad news for ESI workers is that, in effect, they help pay the penalties owed by other workers’ employers, in the form of lower wages. The good news for non-ESI workers is that their wage is not depressed nearly as much as the penalty itself, which is effectively $3,163 per year.

Because its provisions will effectively favor certain kinds of businesses over others, the Affordable Care Act will also have negative effects on economic productivity (which refers to the value created in the economy per hour worked) and therefore additional effects on average wages. The incentives built in to the ACA will have the effect of distorting the market equilibrium between small and large businesses. In a market economy, small and large businesses take on the types of activities that profit most from their advantages and that minimize their disadvantages; the marketplace, in turn, allocates activity between small and large firms to maximize total value to customers, employees, and owners.

Starbucks, for example, which operates thousands of coffee shops, most of which are company-owned, coexists in many markets with independent coffee shops and with franchised coffee shops like Dunkin’ Donuts. The consumer market for coffee is thereby continually allocating employees, materials, and customers among these types of shops on the basis of location, employee preferences, and consumer tastes. The market at one location may support a Starbucks rather than the other choices because Starbucks’ upscale product or familiar brand appeals more to the customers in that area, or because employees especially appreciate the benefits of working for Starbucks. At the same time, an independent shop may be better positioned in another location, where the owner is especially familiar with the local area’s customers, or where employees appreciate a small-business working environment rather than a corporate one. The market creates value for customers and employees by featuring a mix of suppliers. Forcing (that is, without the consent of any of the market participants) one type of shop to be replaced by another type would destroy some of that value.

The ACA doesn’t force coffee shops to change type; but through its penalties and subsidies, it exerts a strong influence unrelated to the fundamental customer, employee, and owner preferences in that marketplace. The employer mandate pushes small employers to replace large ones—for example, an independent shop would replace one of the Dunkin’ Donuts locations owned by a multiunit franchise—because the large employer is handicapped by the costs associated with the employer mandate.

Starbucks was already offering health insurance to its employees before the ACA came along, and this benefit gave the firm a well-earned competitive advantage for employees; the ACA erodes some of that advantage. In this way, the health reform might also cause an independent shop to replace a Starbucks location, or an independent shop to open in a location where a Starbucks might have done so.

The ACA will affect the business decisions of other expanding businesses much smaller than Starbucks. Consider Yabo’s Tacos in Ohio, which has grown to three locations and about 45 employees. Yabo’s owner, Scott Bowles, has been successfully developing and managing new locations by himself. He would like to continue expanding that way—company-owned expansion—but the health reform’s employer mandate induces him to expand with franchises instead. The franchise owners may not know Yabo’s product as well as Bowles does, but employment at a Yabo’s franchise would not count against Bowles’s employee total, thereby permitting him to avoid tens of thousands of dollars in penalties or health costs.

Law-induced changes like these affect productivity—generally, in the direction of less productivity—unless the market had previously failed to have enough of the subsidized businesses and had too many of the penalized ones. Activity moves away from large business and toward small business despite the lost productivity because it is moving to avoid the ACA’s employer penalty.

Not all the labor reallocations induced by the ACA reduce productivity. The ACA’s subsidies will lead, among other things, a segment of the population to move from employer-sponsored insurance to individual coverage, and some of these people will improve productivity by doing so because it was inefficient for them to have ESI in the first place (they were sacrificing productivity in order to enjoy the long-standing tax-avoidance advantages of ESI). For example, absent the ACA, there may have been too many Starbucks locations and not enough independent coffee shops because Starbucks is an ESI employer, whereas the independent shops typically are not. Perhaps such instances of productivity gain should be interpreted as the purported ACA-induced surge in entrepreneurship that the law’s defenders have touted. However, this benefit has to be placed in the context of the subsidies involved: the amount of the subsidies that were suppressing entrepreneurship in the first place; and the amount of the subsidies that are being used to get people to give up their ESI. Moreover, entrepreneurship is by no means the only margin on which the ACA operates; among other things, its employer penalty encourages part of the population to give up its individual coverage and get ESI instead.

Reallocations like these are not limited to coffee shops, or even to substitution between large and small firms, because the ACA affects incentives in many other dimensions of business behavior. Table 2 shows the nationwide results. It includes productivity effects of the employer penalty and the exchange subsidies, including those effects involving enhanced productivity. The overall productivity effect is 0.9 percent in the direction of less productivity. In the long run, workers get paid according to their productivity, so 0.9 percent less productivity by itself means that wages are 0.9 percent lower. For the average worker from a low-income family (first column), that means earning $201 less per year for the same amount of work. For the average worker from a moderate- to high-income family (second column), that means earning $600 less per year for the same amount of work. When added to the employer penalty’s effect on workers’ incomes, that’s a combined annual loss of $884 for workers from low-income families and $1,110 for workers from moderate- to high-income families. As a percentage of what these workers would be earning before taxes, those are losses of 4.2 percent and 1.7 percent, respectively.

Table 2. The wage impact of the 2016 employer penalty and exchange subsidies, including induced<br />
productivity losses

To summarize: before the ACA, non-ESI employers (that is, employers not offering coverage to their full-time employees) operated at a competitive disadvantage and had either to pay extra for employees—an example of the “compensating difference” that Adam Smith wrote about—or be content with workers who didn’t want employer health insurance. The ACA reduces or even reverses the competitive disadvantage experienced by non-ESI employers in the market for low-skill workers. Meantime, a growing body of research is finding that productivity in economies is depressed by misallocations of resources across sectors, regions, and firms. By itself, the employer penalty will depress wages by about $600 per year, even among workers whose employer is not penalized. Productivity losses from the exchange subsidies and employer penalty together add another $400–$500 per year to the wage losses from the ACA. Overall, the ACA will reduce wages by $1,000 per year—about 4 percent of wages for workers from low-income families and nearly 2 percent of wages for workers from high-income families. None of this counts the additional effect of the employer penalty on overall employment, which will further reduce worker incomes.


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