The devastating Obamacare tax on low income workers at large firms

Overburdened worker by Shutterstock.com

Union outrage over Obamacare stems from a much larger problem affecting a broad swath of workers-not just those who happen to have union health benefits. Obamacare levies a grossly unfair tax on workers in large firms-a tax that is particularly unfair since it hits those with the lowest wages hardest. The tax also is very inefficient as it will lead to all sorts of distortion in labor markets.

What is the Obamacare Tax on Low Income Workers?

As Avik Roy explained months ago, the misguided employer mandate arose due to concerns that large numbers of employers would elect to drop their coverage and dump their employees onto the health exchanges.  The reason they might do this is because for many workers, the subsidies available to those who purchase exchange coverage are massively higher than the subsidies available to workers who purchase coverage through their employer.

Careful calculations by researchers at the Urban Institute have shown that a small firm worker in a family of 4 earning a poverty-level wage ($24,000) who will be eligible to purchase coverage through the exchange will get a tax-paid subsidy of $18,432. This includes a premium subsidy of $13,598 (leaving the employee responsible for paying $502, which is just over 2% of family income) and an additional subsidy of $4,834 (leaving the employee responsible for $166).[1]  An equivalently-compensated worker working for a large firm who obtains the identical health plan through his employer would receive no tax subsidy whatsoever. In fact, due to the peculiarities of the Earned Income Tax Credit (EITC), that worker actually would end up paying $123 more in federal taxes than his small firm counterpart who receives no employer-provided health benefits whatsoever![2]

But the story gets much worse. Because the large firm worker is getting employer-paid health benefits, his cash compensation is $11,000 lower than his counterpart working for a small firm. Take a moment to let that sink in. The small firm worker, who earns $11,000 more than his large-firm counterpart, is nevertheless getting an $18,000+ tax-paid subsidy for health care while the lower-paid large firm worker absorbs his family's cost of health care ($14,100 in premiums plus $5,000 in out-of-pocket expenses) entirely on his own!

Remember that from an employer's perspective, the total cost of compensation for these two workers is identical (one gets more cash and no health benefits, while the other gets less cash and a Silver health plan that pays 70% of expected health expenses). Thus, the only difference between the two workers is that one works for a large company and the other works for a small company. When one compares these two workers in terms of their net cash income after taxes and after health care, Obamacare effectively imposes a tax of 142.9% on the large firm worker. That is, such a worker could increase his family's net cash income by 142.9% simply by working the identical job at a small employer not subject to the mandate!

Why the Obamacare Tax is Grossly Unfair

In public finance theory, horizontal equity is the idea that people with a similar ability to pay taxes should pay the same or similar amounts. This Obamacare tax on low-wage workers working for large employers flagrantly violates that fundamental principle. Perversely, this tax on working at a large firm gets bigger as the ability to pay it declines. But note that for the family of 4 illustrated in the chart, it does not disappear entirely until workers are earning more than 350% of poverty (about $85,000).[3]


Can you believe this? Three-quarters of the nation's workforce works in large firms subject to the employer mandate (50 or more workers). The lion's share of these workers are going to be subject to this Obamacare tax simply because they work at large firms. How is that possibly fair? Do you recall President Obama ever announcing that to bankroll his new health plan by penalizing low-wage workers who happened to work at large firms?  Can you imagine the firestorm of protest that would have erupted had he been so honest?

Now you understand why unions are so angry. Union workers are more likely to work in large firms subject to the mandate. They bargained for years to give their employees health benefits. The employer tax exclusion has given them a subsidy that helps reduce the cost of these health benefits. But Obamacare inexplicably turns around and gives their counterparts in small firms massively larger subsidies while making the large firm workers ineligible for subsidies in the Exchange.

Why the Obamacare Tax is Inefficient

Of course the reason for the employer mandate that gives rise to the Obamacare tax is that policymakers "needed" the $140 billion in projected revenue from employer penalty payments in order to help bankroll the advertised $1 trillion cost of Obamacare. As well, policymakers "needed" to hold down the cost of the Exchanges by doing everything possible to create a firewall between employer-provided coverage and the Exchanges. But employers have 4 ways to circumvent that firewall or reduce the burden of the employer mandate.

Forcing Workers into Part-time Status. First, they can make their workers ineligible for coverage by reducing their hours below 30 hours per week. We have seen many employers begin to do just that. In fact, the entire economic recovery has been distorted as employers get ready for Obamacare. Not only have many workers seen their weekly hours get cut below 30 so that they are no longer eligible for employer health benefits, but new hiring has been severely altered as well. In 2013, so far, we've added 4 new part-time workers for every full-time worker entering the labor force, whereas last year the ratio was nearly 6 full-time workers for every part-time worker. In June, we lost 240,000 full-time jobs even as we gained 360,000 part-time jobs. We're now at a situation where "Americans by the millions are in part-time work because there are no other employment opportunities as businesses increase their reliance on independent contractors and part-time, temporary and seasonal employees."

Dropping Coverage. Second, employers can drop coverage, in which case the employer must pay a penalty of $2,000 per worker excluding the first 30 workers as long as the employer has at least one employee who receives subsidized coverage through the Exchange. Whether this makes economic sense for an employer depends on the wage distribution of workers, with low-wage employers being the most likely to make this shift. Moving away from employer-based coverage to individual coverage that is personalized and portable is not necessarily inefficient, for all the reasons Avik Roy has explained in post after post after post. But of course, the incentive to let the employee obtain heavily subsidized Exchange coverage would exist even without the financial penalty. Since the penalty increases the cost of hiring that worker, the employee ultimately will end up paying that penalty in the form of lower wages. This means that even for large-firm workers who end up with the identical subsidized coverage on the Exchange as their small-firm counterparts, they will implicitly be paying roughly $2,000 for their coverage whereas their equivalently compensated peers at small firms will not. In short, there is no escaping the Obamacare tax, although its size can be reduced.

Making Coverage Unaffordable. There's a third avenue to getting large-firm workers onto the Exchange. Since high-paid workers get a bigger subsidy from the tax exclusion than the Exchanges, it would not make economic sense for a company to drop coverage merely to help out a relatively small fraction of low-wage workers who would be better off. Instead, it may actually make more sense to offer very comprehensive coverage with a high worker premium contribution that makes it "unaffordable," meaning that the premium for single coverage exceeds 9.5% of the worker's wage. For a single worker with a poverty-level wage ($11,800), the premium for Silver coverage would be $5,200, so the affordability trigger would be tripped if the employee share exceeded $1,121.  Since the employee share of premiums also can be made tax excludable using a Section 125 plan, high-wage workers should be indifferent about whether the employer pays the entire premium behind the scenes or instead pays the worker a correspondingly higher wage and lets the worker pay the full premium. The tax subsidy and worker's net income after taxes and health expenses will be the same in either case. But for every worker who ends up on the Exchange because their employer coverage is unaffordable, the firm must pay a penalty of $3,000. Like the $2,000 penalty for not offering coverage, this "employer-paid" penalty actually will be borne by the worker.

Making Coverage Inadequate. Another way of minimizing the financial burden of the Obamacare tax is to offer "skinny" coverage, as described in detail by Avik Roy. Employer plans outside of the Exchanges are required to offer preventive health services without cost sharing and cannot have annual or lifetime dollar limits, but otherwise are permitted to be very limited in scope, e.g., excluding hospital services, for example.  Even if employees have access to affordable coverage that is below the 9.5% threshold, they can nevertheless qualify for subsidized coverage on the Exchange if the coverage provided does not have an actuarial value of at least 60%, meaning that it covers at least 60% of the expected medical expenses of those with employer-provided health coverage.  Consequently, this approach is inefficient in that in order to get adequate coverage, employees would end up with two separate insurance policies each with its own overhead costs and the potential for creating coordination of benefits issues.

Indeed, all these end-arounds are by definition inefficient. If they were not, employers already would have undertaken them without the inducement of Obamacare to do so. The lost productivity resulting from part-time workers who would prefer to be working full-time is obvious. It may be harder to measure the loss to the economy as firms restructure how they do business not with an eye to improving their efficiency, but simply in response to a misguided employer mandate.

The foregoing does not exhaust the reasons that repeal of the employer mandate is the most advisable course of action. But it's a pretty good start.

 

Update 1: July 17, 2013

I have corrected a mistatement in the original post regarding "skinny" coverage: "However, this avenue is open only to self-insured health plans. Employers who purchase their coverage through insurance companies are subject to all the essential health benefits requirements that preclude this end-around."  Reader Mario K. Castillo is quite correct that the "skinny" coverage option is available to any large employer whether or not self-insured.  My apologies for the error and my thanks to Mario for spotting my goof.  The impetus for self-insuring arises from a different set of Obamacare rules regarding Minimum Loss Ratios, which do not apply to self-insured plans.  Thus, my original comments about the potential adverse risks of self-insurance are still valid, but they aren't relevant to a discussion of the Obamacare tax: "As it turns out, 68.5% of firms with 50 or more workers already have self-funded health benefits (the figure is 81% for firms with 200 or more employees). Self-insurance is not without risks since a single $100,000 catastrophic health bill obviously will impose a lot bigger per capita burden on a firm with 50 workers than a firm with 5,000. According to the Wall Street Journal's small business reporters: "That is why most large insurers have generally offered such services to companies that have 100 or more workers and can spread the costs around.""

 

You can follow Chris Conover on Twitter @ConoverChris

Footnotes

[1] All figures are in 2016 dollars, as reported in Stephanie Rennane, C. Eugene Steuerle, Health Reform: A Four-Tranche System Updated and Revised. Urban Institute, February 11, 2011. The Urban Institute estimates are based on the costs projected by CBO of the second-lowest "Silver" plan since that is what determine the subsidy levels in the Marketplace (a "Silver" plan has an actuarial value of 70% meaning that it would cover 70% of the expected expenses of a typical plan member, with the balance paid by the family out of pocket).

[2] As shown in Rennane and Steuerle's Back-up One Earner table, the small firm worker would pay an additional $1684 in payroll taxes ($842 paid by worker plus $842 paid by employer, which is presumed to come out of cash compensation that otherwise would be given the worker), but would receive an EITC payment that was $1807 higher than the large firm worker (since the small firm worker's earned income is higher!). The net difference is $123 in higher taxes. This admittedly is unusual. In all other illustrations, i.e., 125% of poverty and above, the Urban Institute calculations show that the workers with employer-provided health benefits do obtain some subsidy from the current tax exclusion, but even so, the subsidy on the exchanges is typically much higher. For a small firm worker at 125% of poverty, for example, the exchange subsidy is $13,762 higher than the subsidy for employer-provided health benefits.

[3] Please note that the chart is for households with one worker; for such families, the "crossover point" (where the tax subsidy exceeds the exchange subsidy) does not occur until 350% of poverty ($84,000 a year); however, for those with two workers, it occurs just after 275% of poverty ($66,000) and for single workers, it occurs just after 225% of poverty ($26,500). So the exact point at which Exchange coverage is a better deal than the same coverage obtained through an employer depends on family size. But for all family sizes, the Obamacare tax gets larger as the worker's earnings go down.

[4] Technically, as described by the Center on Budget and Policy Priorities, "Employers must offer what the legislation refers to as "free-choice vouchers" to employees whose share of the premium for employer-sponsored coverage would be between 8 and 9.8 percent of their income. The amount of an employee's voucher would equal the contribution the employer would make to its own health plan on behalf of the employee, and the employee could use the voucher to purchase insurance in the exchange. Employees receiving free-choice vouchers are not eligible for subsidies." This provision simply amplifies the incentive of employers to make employees responsible for all or most of the premium.

 

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Christopher J.
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