In a recent paper for the University of Chicago’s Becker Friedman Institute, MIT health economist Amy Finkelstein and three colleagues point out the obvious: taxing higher income people and subsidizing lower income people would reduce inequality.
Specifically, they examine what would happen if the U.S. government nationalized the financing of employer-provided insurance, paying for the insurance with a hefty payroll tax. Here’s their abstract:
Over half of the U.S. population receives health insurance through an employer, with employer premium contributions creating a flat “head tax” per worker, independent of their earnings. This paper develops and calibrates a stylized model of the labor market to explore how this uniquely American approach to financing health insurance contributes to labor market inequality. We consider a partial-equilibrium counterfactual in which employer-provided health insurance is instead financed by a statutory payroll tax on firms. We find that, under this counterfactual financing, in 2019 the college wage premium would have been 11 percent lower, non-college annual earnings would have been $1,700 (3 percent) higher, and non-college employment would have been nearly 500,000 higher. These calibrated labor market effects of switching from head-tax to payroll-tax financing are in the same ballpark as estimates of the impact of other leading drivers of labor market inequality, including changes in outsourcing, robot adoption, rising trade, unionization, and the real minimum wage. We also consider a separate partial-equilibrium counterfactual in which the current head-tax financing is maintained, but 2019 U.S. health care spending as a share of GDP is reduced to the Canadian share; here, we estimate that the 2019 college wage premium would have been 5 percent lower and non-college annual earnings would have been 5 percent higher. These findings suggest that health care costs and the financing of health insurance warrant greater attention in both public policy and research on U.S. labor market inequality.
The paper is Amy Finkelstein, Casey C. McQuillan, Owen M. Zidar, and Eric Zwick, “The Health Wedge and Labor Market Inequality,” Working Paper No. 2023-50, April 2023. McQuillan and Zidar are at Princeton University and Zwick is at the University of Chicago.
Notice in the first sentence their reference to the current way of financing employer-provided health insurance as a “head tax.” My guess is that they want people to think that the current way of financing is kind of like a tax but their intellectual honesty requires them to put the term in quotation marks. Because, of course, it is not a tax.
The payroll tax that they consider is large: 11 percent. They write:
For our baseline analysis (with τ = $7, 758), we calculate that the counterfactual, equilibrium payroll tax t would be 11 percent. That is, switching to payroll tax financing would add an additional 11 percent to existing payroll and income tax rates.
That second sentence is incorrect. Adding an 11 percent payroll tax would not add “11 percent to existing payroll and income tax rates.” It would add 11 percentage points, a different matter indeed.
Interestingly, in their abstract Finkelstein et al. note that with such a tax replacing the current system, “non-college employment would have been nearly 500,000 higher.” That makes sense. But wouldn’t college employment be lower? Yes, it would. On page 8 of their Appendix, they point out that college employment would fall by 371,593, non-college employment would rise by 457,288 and total employment would rise by only 85,696. But they don’t seem to think that although an increase of nearly 500,000 jobs for workers who are not college graduates is worth mentioning in the abstract, a loss of “nearly 400,000 college jobs” is not.
Their analysis is positive, not normative. So one can’t necessarily conclude that they are advocating such a hefty payroll tax. My guess is that they are, though. One reason I think that is that they quote, without commenting, Emmanuel Saez and Gabriel Zucman’s statement that the current system of employer/employee financing “is the most unfair type of tax.”
They do point out how huge a bite health insurance takes out of pay, especially for workers without a college education:
Average insurance premiums for employer-provided health insurance were about $12,000 in 2019. This amount is about 25 percent of the average annual earnings for a full-time, full-year worker without a college education (about $50,000), and about 12 percent of the average annual earnings for a full-time, full-year college-educated worker (about $100,000).
That 25 percent number is shocking but true. Of course it’s possible that the average worker gets large value from these expenditures. But the authors don’t address that.
Are there other ways of making health insurance cheaper by making health care cheaper? There are. The federal and state governments could deregulate supply, allow more immigration of doctors, and get rid of the requirement that a doctor be a middleman for prescription drugs, as is done in some other countries. Unfortunately, the authors consider none of these ways.
The second-last sentence in their abstract is interesting. Why mention reducing health care spending as percent of GDP in the United States (16.8 percent in 2019) to the much lower percent in Canada (10.8 percent), a reduction of 37.5 percent, unless the authors are treating as a serious option the imposition of Canadian-style rationing?
Note: The Becker Friedman Institute is, of course, named after Gary Becker and Milton Friedman.
READER COMMENTS
Andrew_FL
Apr 25 2023 at 9:42am
I find it interesting that payroll tax funding is more “effective” in their findings than drastically reducing healthcare consumption.
vince
Apr 25 2023 at 6:17pm
Where to start? Adjust premiums for BMI, eliminating that subsidy.
The system seems rigged by design. It’s almost impossible for someone to see what he really pays. The ACA caps premiums to a percentage of the insured’s income. The excess–whatever it may be–is paid by the government. The healthcare industry can increase revenue by lobbying for more healthcare spending.
The ACA caps administrative costs of insurance companies to 20 percent. If an insurance company spends less than 80 percent of premiums on healthcare, it has to reduce admin costs, including executive salaries and bonuses. It’s easy to see what that incentivises.
Roger McKinney
Apr 26 2023 at 10:46am
Good ideas, buy currently all illegal!
Jose Pablo
Apr 25 2023 at 7:35pm
If the objective function is to maximize non-college employment, why stop at health insurance?
You could do the following:
1.- Legislate that employers are obliged to reimburse the car insurance cost of their employees (after all they mostly use their vehicles to get to work so there would be a logic to this new law … not that Congress needs a logic to enact a new regulation, anyway)
2.- Pay for this new perk with a statutory payroll-tax on firms
I am pretty sure that using the same model you will find that this increases non-college employment …
But wait, why stop at car insurance? Why not do the same with grocery expenses and travel expenses?
Wait, I have an idea: the employers should pay for all their employees’ consumption up to a maximum amount to be stablished. Let’s call this amount the “Flat Employee Consumption Amount” (FECA)
This FECA:
1.- Will be the same for all the employees (every single one)
2.- Will be financed by a statutory payroll-tax on employers
I am pretty sure that:
1.- Inequality would be greatly reduced (in fact, will disappear … like totally)
2.- Non-college employment will be maximized
Afterall, why should firms pay for their employees’ health insurance and not pay for their employees’ meat or milk consumption?
vince
Apr 25 2023 at 11:58pm
Let’s call this amount the “Flat Employee Consumption Amount” (FECA)
Or Flat Employee Consumption Allowance (FECAL).
Thomas Hutcheson
Apr 26 2023 at 11:33pm
I think that is the policy implication. The US system of employers using part of workers compensation to purchase health insurance is screwy (“uniquely American” in the words of the authors). Presumably is continues only because the public would blanch at knowing how large the tax credit would need to be for everyone to purchase their own insurance.
nobody.really
Apr 27 2023 at 12:12pm
Not ENTIRELY screwy.
Insurers must cope with adverse selection. You might expect that, all else being equal, the price to insure someone would reflect the average cost of covering someone, plus some profit margin. But you have more information about your risk than the insurers do, and will act on that info. Specifically, people who know that they bear an abnormally high chance of incurring high medical bills will be more willing to buy medial insurance (and more insurance) than people who know they bear an abnormally low chance of incurring high medical bills, all else being equal. Bearing this fact in mind, insurers will have an incentive to raise the price of the policy they offer you to cover more than the estimated cost of insuring you. But as the price goes up, ever fewer people will be willing to buy that insurance—except for the exceptionally risky people. Conceptually this dynamic continues until only people who know that they will wrack up large bills will bear the cost of insurance, and the price of the policy will reflect the fact that all policy owners know that they will incur large medial bills.
How to manage this dynamic? Group policies. If an insurer can offer a policy to a group of people—a group not picked on a basis that would correlate with high medical bills—then the insurer will have greater confidence that the cost to insure the group will reflect AVERAGE health care costs. This permits the insurer to offer lower-cost policies, which in turn inspire even low-risk people to buy the policies, generating the revenues the insurer requires to offset the cost of high-risk individuals.
Because employers are not disproportionately likely to hire people who need lots of health care, employer-based group policies make some sense. I would be interested to learn whether we observe group insurance policies in other nations—especially nations with weak/no social safety nets.
Thomas Hutcheson
Apr 29 2023 at 10:25am
Yes, but just giving everyone a tax credit to buy their own insurance (there could be a public option if we do not want to mandate community rating) would avoid adverse selection and also get around the differential tax on employing low wage workers, the “head tax.”
Thomas Hutcheson
Apr 25 2023 at 10:26pm
I was disappointed that they did not model replacing the wage tax with a VAT for financing health insurance.
nobody.really
Apr 26 2023 at 8:16am
…or, say, a conventional (progressive) income tax?
Thomas Hutcheson
Apr 26 2023 at 2:18pm
I see you are not a “Radical Centrist” (the name of my Substack :)) like me.
Seriously, I actually prefer redistribution between status (sick/not sick, employed/not employed, working years/post working years, raising children/not raising children, etc.) to be financed with a flat consumption tax and leave the personal income tax to pay for government operations and to transfer income across before-tax income levels. [The tax on net emissions of CO@ is only for changing incentives, not for transferring income at all, so its revenue would be rebated.]
nobody.really
Apr 26 2023 at 8:42pm
Why flat?
Thomas Hutcheson
Apr 26 2023 at 11:40pm
To separate redistribution for life situations that anyone might be in from time to time, from consumption redistribution from high to low income people. To do both with progressive consumption tax might create overwhelming incentives to hide and re-define “consumption.”
Roger McKinney
Apr 26 2023 at 10:56am
You’re right that the state severely limits the supply of healthcare. Also, it creates virtually unlimited demand through Medicare and medicaid. Employer subsidized insurance contributes to excess demand by hiding the cost from employees. As a result, medical costs rise 10 -15% every year. It’s a ridiculously stupid system!
Insurance companies pay 85% of premiums to doctors and hospitals according to Arthur Anderson. 10% goes to admin and 5% to profits.
steve
Apr 27 2023 at 10:07am
If you discuss Canadian rationing then you also need to discuss American rationing. Its a matter of trade offs, but in pretty much every survey ever done countries with Canadian style rationing are happier with their health care than Americans with their health care. Plus, its a lot cheaper in other countries.
Also, since you arent a health care economist are you aware of the literature on Provider Induced Demand? The assumption that having more immigrant docs here will lower costs may not be true, or only true after being a large increase in total spending.
Steve
David Henderson
Apr 27 2023 at 4:38pm
You write:
It’s definitely cheaper; I’ll grant you that. But the rationing in Canada is way more extreme than in the United States. The Fraser Institute in Vancouver, Canada issues an annual report documenting the waiting times province by province.
I think you’re correct about the surveys, but here’s what you’re missing: the vast majority of Canadians are not in extremis. So when they’re surveyed, they don’t have big complaints. It’s when they actually experience the system that they see the problems. As I said once on a talk show in Winnipeg (I’m originally from Manitoba), “The Canadian health system is great, as long as what you have is just a cold and you don’t mind waiting a few hours to see a doctor.”
You write:
Actually, I was the senior economist for health policy between 1982 and 1984 with the President’s Council of Economic Advisers. My boss, Martin Feldstein, had probably been the world’s leading health economist in the late 1960s. He seemed to think I was a health economist. It’s true that I follow health economics less than I did during those 2 intense years, but it never goes away. And yes, I was aware of that literature. The classic claim was made by Shain and Roemer in 1959 and by Roemer in 1961. Later work by Rossiter and Wildensky found weak evidence for it, specifically that a doubling of the physician/population would lead to an 11 percent increase in physician-initiated visits. One reason, I suspect, is that many people in the United States, as opposed to many other countries, still pay at least a small co-ayment or coinsurance for a visit or test.
steve
Apr 27 2023 at 8:17pm
Ouch! I apologize for not knowing your background and really didnt mean for that to come off as snarky but its not an issue that most non-health care people have much familiarity with. The Wildensky study was done in another era. We now have much better and more targeted advertising. We also have a number of studies showing that for high priced procedures pts can be fairly price insensitive to out of pocket costs so those dont always cut usage.
You also have pt induced demand, which can be difficult to sort out but there are large areas of the country that are underserved. This is also one of those things where I think it helps to work in the field and watch how hospitals and providers work. They clearly engage efforts to increase income, often by increasing the number of procedures/tests/visits that they control. When docs own the MRI center more MRIs get done. So, I would fairly confidently say that if you greatly increase the number of docs immigrating here total medical spending will increase a lot. Pay for individual docs might eventually decrease but total spending is what counts. Its not so much doctor salaries that affect costs as the spending that they order.
I would say wait times are tricky. In the US wait times can be infinite if you dont have insurance. Wait times overall are shorter in several other countries like Japan (see link), but the US does have very short wait times for the more costly, elective procedures. Stuff like total joints and cataracts, not people in extremis. Wait times in the US for primary care is different, with wait times in Canada for those visits close to ours. If its urgent (in extremis), wait times are same as in the US. Since only 1/3 of docs in the US are PCP vs 50% in Canada it makes sense. I have several docs and a couple of mid levels who are Canadian. They are more medically sophisticated but they seem to think its pretty well understood that Canadians have made a trade off. They could have shorter wait times for elective procedures if they wanted, they just have to spend more. (Of note, Kaiser in CA has somewhat embraced the Canadian model with fewer specialists and emphasizing PCP.)
Query- Since there needs to be a salary gradient to drive foreign docs to move here, how large does that need to be? Have looked without success for literature.
https://www.commonwealthfund.org/publications/surveys/2021/oct/comparing-nations-timeliness-and-coordination-health-care
Steve
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