Friday, October 29, 2010

Some Economics of the Employer Mandate

It is exceedingly difficult to figure out from the text of the health bill itself just what are the employer responsibilities under the new health bill. First, which bill does one actually look to? The original House bill, the Senate bill, or the reconciliation bill? I have yet to sort that out...which gives you an idea why people can be justifiably upset about this legislation.

But I trust some lawyers and accountants to sort it out for me. See here for a nice summary piece from the law firm Mintz Levin. I have seen other descriptions that are the same, so I think this is correct.

The basic employer responsibility is two-fold: one, provide "minimum essential coverage" to your employees; and two, make sure it is affordable. Affordable is obviously a key definition. From the Mintz article: "...coverage is deemed "unaffordable" if the premium required to be paid by the employee exceeds 9.5% of the employee's household income." Also, a plan is unaffordable if it covers less than 60% of the total cost of benefits. That 60% rule is actually quite complex, as it involves the actuarial value of the plan with a standard pool of participants. Take a standard pool of participants, simulate them through your health plan -- if the participants pay more than 40% of total costs (through deuctibles and copays) on average, then you do not have an affordable plan.

If the employer does not offer coverage or affordable coverage, it will pay a penalty. The calculation of such penalty -- or is it a tax? -- is itself complicated, depending on the number of employees not being offered coverage and who get a subsidy on insurance they buy on their own (remember there is an individual mandate too). Let us say that it is $3000 per year per employee who does not get offered affordable, minimum essential coverage.

As I write this, I realize just how complex all of this is, and think that perhaps the biggest burden on business is going to be paying the accountants, lawyers and consultants to figure all this out. If the rate of business formation takes a hit, I for one won't be surprised.

But my main focus in this posting are the economic effects of the employer mandate on the labor market.

The basic economics would seem to be the following. Employers must offer employees subsidized insurance in additon to any wage paid. This lowers the demand curve for labor by the cost of the insurance to the employer. Employees get a subsidy, therefore the supply of labor also shifts down by the value of the insurance to the employee. The supply/demand figure shown here illustrates the shifts in the demand and supply for labor.

The key issues are these: (1), Is the cost of the insurance to the employer equal to the value of the insurance to the employee? (2), Can wages freely adjust?

As to point (1), if we took the position that $X of insurance provided by the employer must be valued at $X by the employee, then the way I have the curves depicted would be correct. The demand curve shifts down by $X and the supply curve also shifts down by $X (think of the wage and the insurance all being in annual amounts). Then the new equilibrium is at the same quantity, but at a wage that is reduced by $X. Think of it like this: The government says that employees must be paid 90% in cash and 10% in a dollar-based voucher that can be purchased on a dollar for dollar basis and can be spent on anything. Then the cost of a $1 voucher is $1 and the value to the employee is $1. Clearly this does not affect the equilibrium except that some of the wage is paid in vouchers instead of cold hard dollar bills.

In this case of health care, however, employees do not get vouchers for anything but they get a specific good, health insurance. Economic theory shows that payments in kind are generally worth less than payment in cash. That many employees do not now spend their money on insurance supports this idea. So in this case, the supply curve would shift down less than the demand curve shifts down, and employment will fall.

There is a counterargument, based on the market failure in insurance markets. Suppose that adverse selection is making insurance either unavailable or priced such that some individuals choose not to buy the policies available. Then $X of insurance offered by an employer could not only be valued at $X but even by more than that. In this case, the supply curve of labor would shift down by at least as much as the demand curve falls, and employment could even increase.

Point number (2) from above, can wages freely adjust, is also important to consider. First, wages are notoriously sticky downwards. This is the main reason why labor markets do not clear and we get unemployment. With sticky wages, the adjustments pictured in the graph will not happen, or at least not quickly. Labor demand will drop and labor supply might increase, but the money wage will not fall by the value of the insurance. In this case, labor demand will determine employment, which will be lower than before -- at the point where the old wage intersects the new and lower demand curve. Since more people are willing to work than before, there is observed unemployment.

Another reason for sticky downward wages is the minimum wage. To the extent that the current wage is already above market clearing levels because of government mandate, employment is already being determined by the labor demand curve alone. As that shifts down because of the insurance mandate, employment falls and measured unemployment increases.

The summary of all this? Using my prior beliefs on the differential value of insurance between employer and employed (reasonably higher to the employee) and the very significant downward inflexibility of wages, I predict less employment.

1 comment:

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