• Individual Mandate Penalties Are Adequate

    This post has been cited in the 1 April 2010 edition of Health Wonk Review. See also my follow-up post on this topic.

    Some have asserted that the individual mandate penalties under the Affordable Care Act (ACA) are lower than those imposed in Massachusetts. If that were the case then it would be one reason why one couldn’t generalize the experience in Massachusetts where guaranteed issue exists and near-universal coverage has been achieved with low penalties. If ACA penalties are lower than Massachusetts’ penalties then there is reason for concern that individuals might game the system–buying coverage only when sick, paying the low penalty when coverage isn’t needed–more than they appear to in Massachusetts.

    So, are ACA penalties lower than those in Massachusetts? This is an empirical question, and I can answer it. The details are below, but to cut to the chase, the ACA penalty will be $674 for an average U.S. resident while the Massachusetts penalty would be $537 on average. That doesn’t mean the ACA penalty is higher for everyone. About 40% of the population would have a higher penalty under Massachusetts rules than under ACA rules. However, nearly half of those who would have a higher Massachusetts than ACA penalty are exempt from ACA penalties due to low income. Many such individuals are eligible for premium and cost sharing subsidies under ACA. Thus, the incentive for gaming is lower for this subset.

    So, I don’t think it is fair to say the ACA penalties are lower than Massachusetts’ penalties. On average they’re higher, and they’re higher for 60% of of the population. If gaming is low in Massachusetts we cannot expect it to be higher under ACA based on a penalty-size argument. Hence, ACA penalties are not too low. However, the U.S. population may differ from the Massachusetts population, and other details of ACA differ from health reform in Massachusetts. For these reasons, gaming may still be an issue despite the evidence on penalty size.  Keep reading if you want the details.

    Let’s first look at the Massachusetts penalty schedule for 2010:


    FPL = Federal Poverty Level. This table is copied from the Massachusetts Department of Revenue website. I believe the 18-26 age specification in the 250.1-300% band is in error, that the dollar figures in that band apply to all ages. The penalty figures shown are per adult (i.e., married couples pay double, kids are exempt).

    When fully phased in (2016), the penalty under ACA will be $695 per person per year up to a maximum of three times that amount ($2,085) per family or 2.5% of household income, whichever is greater. For the penalty calculation, children under 18 count as half a person (i.e. lead to a penalty of $374.50–h/t reader Jacob Shmukler). Individuals with out-of-pocket (OOP) premium-to-income ratio above 8% are exempt from the penalty. Here, OOP premium is net of employer contribution or exchange subsidies (source for premiums: 2009 Kaiser/HRET Employer Health Benefits Survey; premiums for employer-sponsored plans not reduced by the tax subsidy, which is conservative).

    With a nationally representative source of income data we can calculate what proportion of individuals would face lower penalties under ACA than in Massachusetts. To answer these questions I turned to the Medical Expenditure Panel Survey (MEPS) because I have it handy and am very familiar with it. One could also use the Current Population Survey or any number of other nationally representative surveys with income data. Because it is the latest available, I used the 2007 version of MEPS. I didn’t trend incomes forward to 2010, which is conservative to the extent incomes went up (but given the economy they likely have not).

    I computed the penalty paid by each family in the MEPS sample under each set of rules, ACA and Massachusetts. I then assigned to each individual in each family an equal share of each penalty and averaged the penalties over the population, weighted appropriately to compute national means. I also computed the number of individuals for whom the ACA penalty would be greater than the Massachusetts penalty. Results:

    • Mean ACA penalty: $674
    • Mean Massachusetts penalty: $537
    • Percent of population for whom ACA penalty > Massachusetts penalty: 60%

    These results are qualitatively robust after stratifying according to exchange subsidy eligibility. Since there is little evidence of substantial gaming in Massachusetts, based on an analysis of penalty size alone there would seem to be little cause for concern over gaming under ACA, particularly for higher income individuals. This analysis ignores other differences between Massachusetts and its health reform law and the national population and ACA, respectively. Results are sensitive to assumptions, but I deliberately selected those conservatively as indicated above.

    • What do you think about the enforcement issues raised by Tyler Cowen?


      How do the ARA enforcement tools compare to MA?

      • @Chuck – I don’t know, and it is a good question. In general I think it is sensible to be concerned about these things, but not overwrought. Stuff like this can be tweaked. However, I for one do not understand the point of a mandate with dull teeth or no bite. As I wrote in a prior post,

        [I]f one really believes in an individual mandate then one should not feel bashful about backing up that policy goal with a penalty with teeth. Nobody would pay it anyway. If one thinks that a high penalty is a political vulnerability then one is admitting moral defeat on the notion of an individual mandate.

    • One additional aspect of this i have yet to see clearly explained is whether insurers will be permitted to use open enrollment windows, similar to those used by employer plans and Medicare, absent a change of life circumstance (e.g. birth or marriage). I believe such windows play an important role in limiting gaming of the system, perhaps as important a role as a fine. Are open enrollment windows permitted in MA? Are they permitted under ACA?

      • @Michael Tehan – Another very good question and one I’ve wondered myself. I think we need to hear from an expert on the MA law. I’m really not. I could Google as well as the next guy but there must be someone out there who can delineate the various ways in which MA and ACA differ that are relevant to adverse selection and gaming. Consider this a guest post offer to any credible expert.

    • Austin:
      This is a great article and much needed. I had been discussing this problem with my friends recently and I excited to be able to forward this to them.

    • Even if there are sizeable incentives to game the system, I don’t think anyone has explained why this necessarily leads to a failure of the system. This seems to be always just assumed by economists (adverse selection, death spiral, yada yada yada). In my simulations, the death spiral never gets very far, unless elasticities are implausibly high.

      Demand Elasticity, Risk Classification and Loss Coverage: When Can Community Rating Work?


      Admittedly I abstract from all specifics of US healthcare. But I have never seen any convincing account of how the death spiral works: it is always just assumed.

    • I do not see where the penalty is limited to three times the applicable amount.

      That is in sec. 5000A(c)(2) before it is replaced by sec. 10106(b)(1). The replacement limits the maximum penalty to “an amount equal to the national average premium for qualified health plans which have a bronze level of coverage, provide coverage for the applicable family size involved, and are offered through Exchanges for plan years beginning in the calendar year with or within which the taxable year ends.”

      So the limit of the penalty for an individual would be about $5,000 and for a family $12,500 (see )

      So the average penalty would be substantially higher than what you state and for wealthy individuals and families, there would be no savings from being uninsured (over $200,000 for individuals, $500,000 for families)

      • @Matthew – “Require U.S. citizens and legal residents to have qualifying health coverage. Those without coverage pay a tax penalty of the greater of $695 per year up to a maximum of three times that amount ($2,085) per family or 2.5% of household income.” (Source: Kaiser summary, a credible and excellent source.)

        This is what I wrote and what I implemented. That is, $2,085 is not a cap. You are right that individuals with high incomes will face a very high penalty (2.5% of income). I don’t see a problem with what I wrote or did.

    • The 2009 FPL for a single person is $10,830 (found here: http://aspe.hhs.gov/poverty/09poverty.shtml )

      For three people, it’s $18,310, but the adult/child composition is not specified.

      So I think the first number is applicable. Three times that is $32,490. This is presumably gross income.

      At this website: http://www.moneychimp.com/features/tax_brackets.htm , I learn the federal income tax on $32,490 is 15%, which is $4456. Social Security is an additional 6.2%, which is $2014, and in addition to this, many states have their own income tax & sales tax. This is before we consider food, rent, transportation & other expense necessary to live. Three times FPL is little more than starvation. A penalty of 2.5% is $812.25.

      • @Dave of Maryland – A family of the type you describe will be subsidy eligible and would be exempt from the penalty if premium-to-income ratio is above 8%.

        • The subsidies are going to be history in any state with a federal exchange. Obamacare plainly states that the federal government can only provide subsidies to people on exchanges created by the “state”. “State” does not mean or imply “federal government”. All subsidies on federal exchanges are plainly illegal under the language of the law which the courts are not going to let the incompetent in the whitehouse who signed the legislation as is re-write to suit his whims.

    • Obamacare has caused my premiums to skyrocket and I am ABSOLUTELY going to be gaming the system. I am simply going to pay the penalty because it’s MUCH cheaper than keeping coverage, thousands of dollars cheaper in fact.. If I get sick with anything serious I am then going to simply demand coverage under the ACA and soak the exchange for 10’s if not 100’s of thousands in expenses. The government which thinks it knows all made the rules and I am going to ruthlessly exploit them to my advantage and so are millions of other people. There is simply NO REASON to pay these absurd rate increases if I can’t be denied coverage after I’m sick. Screw the government and the insurers since they are both trying to gouge me to death on Obunglercare.