Free Rider: Senate Finance’s No Good Very Bad Minimum Wage

This week bloggers and policy wonks ripped into the free rider provision of the Senate Finance health reform bill. Ezra Klein called it “one of the worst policy ideas” he’d ever seen. Robert Greenstein listed it as one of the bill’s “two key problems.” Paul Krugman called it a “terrible idea.”

The free rider provision is a variation of employer mandate in which employers either offer health insurance or pay the subsidies to which their low-income workers would be entitled for purchase of insurance on an exchange.

There are some good reasons to dislike the free rider provision: it is administratively complex and it creates a disincentive for employers to hire workers from low-income families (for which the subsidies would be higher), among others. What the provision does not do is create an incentive to hire higher-wage workers in order to avoid the subsidy payments. That is, it will not lead to fewer low-wage jobs.

To see why, it is relevant that the subsidy is not 100% of the wage, nor is it flat. It trends down with family income. Thus, by hiring a higher-wage employee a firm could avoid the subsidy but not at a lower cost. The increase in wage would be greater than avoided subsidy. Therefore, firms will not increase wages to avoid the subsidy. All other things equal, what the subsidy would do is encourage higher-productivity workers into the workforce because it raises the floor of total compensation (since wages can’t go below minimum wage). That’s just like a minimum wage.

But, as others have pointed out, firms can avoid the subsidy by hiring (at the same low wage) workers from higher income families. That’s the new source of labor market distortion in the free rider provision that does not exist with the minimum wage.

So, the free rider provision is like a minimum wage, only worse. It is a no good very bad minimum wage.

Later: See my follow-up post on the free rider provision, in which I explain how it might work more clearly (or at least thoroughly and precisely) than most.

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