Exchanges needed before altering tax subsidy?

Don wisely wrote, “There could be some concerns about altering this subsidy before insurance is available in exchanges in 2014 which is something to keep in mind.”

He’s referring to the employer-sponsored health insurance tax subsidy, or the fact that at least the employer paid portion of health insurance is not subject to income and payroll taxation. For those with a Section 125 plan, the entire premium, whether paid by employer or employee, is not subject to those taxes. Most with employer-based coverage have such a plan, though this is frustratingly hard to quantify in detail (best I’ve found is noted here and here).

Now, do we need exchanges before altering the tax subsidy, as the Cadillac tax will do in 2018 and as some suggest we should do ASAP? The answer depends on what employers will do. If they continue to offer coverage, then, no, we don’t need exchanges. If they drop coverage in response to the change in the tax treatment of their plans then, yes, we ought to have exchanges in place to catch those who lose access to insurance.

We actually have some evidence about how employer offers change in response to variations in levels of tax subsidy. Those levels have changed over time, differ by state, and vary by individuals and employers according to differing marginal tax rates. Steve Pizer, Lisa Iezzoni and I exploited those variations in our recent working paper, which includes the following summary.

We estimate the elasticity of offer with respect to tax price at -0.56, which is larger in magnitude than Gruber and Lettau (2004) who found -0.25, and closer to Bernard and Selden (2002) who found -0.52 and Gruber (2001) who found -0.77.  Gruber and Lettau use data from an employer survey (the Employee Compensation Survey) and employer surveys typically find higher offer rates than individual surveys (discussed in more detail by Bernard and Selden).  Higher offer rates imply lower elasticities, holding effect sizes constant.  The employer offer rate in our data (66%) was lower than Gruber and Lettau (91%) and lower than Bernard and Selden (83%) who restricted their sample to full-time workers and their families. [See working paper for full references.]

Translation: Tax price is the cost of employer-sponsored insurance in terms of foregone wage. The higher the marginal tax rate, the less in wages one has to give up to get a dollar of employer-sponsored insurance, the lower the tax price. The intuitive way to think about this is that the government is kicking in a larger subsidy, the amount in taxes it does not collect. Offer elasticity is the percent change in the probability of offer divided by the percent change in tax price. All elasticity estimates reported above are negative. As tax price goes up (as health insurance costs more in terms of foregone wage), employers are less likely to offer insurance. The estimates differ in degree of sensitivity, reflecting differences in data and methods.

But, even with those differences, qualitatively we know what to expect from increasing taxation of employer-sponsored plans. It can only encourage employers to drop coverage. Maybe not a lot, but it will have some effect. The effect may be swamped by the countervailing effect of a mandate, say, but there will be some effect. For this reason, it is probably a good idea to have exchanges in place.

I should say a few words about how the foregoing meshes with my post earlier today about employer offers in Massachusetts. As the data show, they have gone up. However, this is not a test of the Cadillac tax or any other substantial change in taxation of employer-sponsored health insurance. I’m not aware of any big changes to how those plans are taxed in Massachusetts (readers, correct me if I’m wrong on this). I think Massachusetts has been a test of the mandates (individual and employer) and subsidies. Changing the tax treatment of employer plans is a different experiment.


Hidden information below


Email Address*