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Let Me Explain The Cadillac Tax

Allan Sloan, in a column criticizing the proposed tax on expensive health insurance plans, says that most of the revenue from this tax wouldn't come from the high-cost plans:

[I]f you look at the actual workings of the plan, you come away far less impressed. You discover that more than 80 percent of the money it raises would come from individuals paying higher income, Social Security and Medicare taxes -- not from soulless employers and insurers.

Bob Herbert made a similar criticism a couple weeks ago:

Proponents say the tax will raise nearly $150 billion over 10 years, but there’s a catch. It’s not expected to raise this money directly. The dirty little secret behind this onerous tax is that no one expects very many people to pay it. The idea is that rather than fork over 40 percent in taxes on the amount by which policies exceed the threshold, employers (and individuals who purchase health insurance on their own) will have little choice but to ratchet down the quality of their health plans.

This like saying, "The dirty little secret about Bob Herbert is that he's paid by a news organization to publish his opinions, which are then disseminated on the carcasses of dead trees." It's not a secret. That's the plan. Nobody is pretending otherwise. Right now, the tax code encourages your boss to compensate you in the form of health care, which is tax-free, rather than wages, which are taxed. The plan is that, by evening out the scales, employers will shift more compensation into taxable wages, thus raising revenue and take-home pay. Proponents are extremely upfront about this.

Sloan, meanwhile, doubts that employers will really try to save on health care costs, or that, if they do, they'll shift the money into higher wages:

Economists at the joint committee and most other places assume -- I'll repeat that: assume -- two things. First, that to avoid this tax, employers will pay less toward health insurance than they otherwise would. Second, that the money employers don't pay on health care will go to employees as higher salaries.

Call me skeptical -- or cynical -- but I find it hard to believe that any employer would pay more to employees if it paid less for health care. I also find it hard to believe that employers can work any harder than they already do to hold down health-care costs. But that's the assumption underlying the idea that the tax will hold down future costs.

Okay, two things. First, Sloan doesn't believe that employers could do any more to hold down health care costs than they already are? What exactly are they doing right now? And even if you think they are doing a lot already, surely scaling back a tax break that encourages lavish spending would encourage them to step up their efforts, right?

Second, economists have produced a shelf of studies suggesting that wages and health care benefits come out of the same pool, and that higher health costs lead to lower wages and vice versa. I yield the floor to Austin Frakt:

Let’s take a look at what some of that literature says.

In a 2006 article in the Journal of Labor Economics titled The Labor Market Effects of Rising Health Insurance Premiums, Katherine Baicker and Amitabh Chandra estimate that a 10% increase in health insurance premiums reduces the aggregate probability of being employed by 1.2 percentage points, reduces hours worked by 2.4%, and increases the likelihood that a worker is employed only part time by 1.9 percentage points. For workers covered by employer provided health insurance, this increase in premiums results in an offsetting decrease in wages of 2.3%.

Since health insurance premiums are plausibly a factor of five or so less than wages (annualized), the 10% increase in the former leading to a 2.3% decrease of the latter is close to a one-to-one trade-off.

But we don’t have to take just Baicker’s and Chandra’s word for it. Others cite similar findings. In a 2008 article in JAMA (link to a full access, low resolution version) Ezekiel Emanuel (yes that one) and Victor Fuchs write that “the health care cost–wage trade-off is confirmed by many economic studies.” In support of this claim they cite the following (extracted from their references):

  • Eberts R, Stone J. Wages, fringe benefits, and working conditions: an analysis of compensating differentials. South Econ J. 1985;52:274-280.

  • Sheiner L. Health Care Costs, Wages, and Aging. Washington, DC: Federal Reserve Board of Governors; April 1999. Accessed February 6, 2008.

  • Royalty AB. A Discrete Choice Approach to Estimating Workers’ Marginal Valuation of Fringe Benefits. Indianapolis: Indiana University–Purdue University; June 2003. Accessed February 6, 2008.

  • Madrian BC. The US Health Care System and Labor Markets. Cambridge, MA: National Bureau of Economic Research; January 2006. NBER Working Paper No. 11980. Accessed February 6, 2008.

  • Gruber J. The incidence of mandated maternity benefits. Am Econ Rev. 1994; 84(3):622-641.

  • Miller RD. Estimating the compensating differential for employer-provided health insurance. Int J Health Care Finance Econ. 2004;4(1):27-41.

  • Gruber J. Health insurance and the labor market. In: Culyer AJ, Newhouse JP, eds. Handbook of Health Economics. Vol 1. New York, NY: Elsevier Science; 2000.

Clearly the notion that premiums and wages offset one another has an impressive pedigree.

There may be evidence to the contrary, but I haven't seen any of the critics produce it. Lest you worry this is all too theoretical -- Sloan keeps emphasizing that it's an "assumption" -- Ezra Klein also had a chart showing just how this relationship worked over the last two decades:

Update: Ezra now says the chart proves too much -- the rise in health costs isn't large enough to drive the wage trends. My faith in infographics has been shaken to the core. But my faith in the Cadillac tax remains ardent.