• Gruber’s Latest Paper on Employer-Sponsored Health Insurance

    Today NBER released a paper by Jon Gruber on the tax exclusion (a.k.a tax subsidy) for employer-sponsored health insurance (ESI). Since its content relates to that of many of my prior posts I will draw out a few points I haven’t already raised or that answer some questions I’ve had.

    Gruber claims, without citation, that about 80% of those with ESI have access to Section 125 (cafeteria) plans. I wondered about something like this before. Because employee contributions to non-cafeteria plans are taxed the tax exclusion does not apply to every dollar of ESI premiums. Note that the word “access,” in bold above, is his. He is not saying that 80% are enrolled in a Section 125 plan. So this doesn’t exactly answer my question about what proportion of workers are in such plans. A citation would have been helpful.

    Gruber correctly points out that a significant benefit of the ESI tax exclusion: it supports the risk-pooling benefits of the employer-based system. One concern is that employers will cease offers of insurance if the tax subsidy were to vanish. Based on his own work (the extensive margin is relatively low) Gruber writes that if the tax exclusion were repealed “there is no reason to think that there will be a wholesale exit of medium and large firms from ESI.” Perhaps a gradual erosion is more likely.

    On the other hand, the tax exclusion also promotes purchase of too much insurance (the intensive margin is relatively high). Gruber briefly surveys some of the literature on this point. He also notes the well-known labor market distortions due to an employer-based system that include “limited job to job mobility and distorted retirement decisions.”

    Gruber then turns to a brief summary of his microsimulation model that he uses to estimate the effects of changes to the ESI tax exclusion. The model is based on data from the Current Population Survey and the Medical Expenditure Panel Survey and relies on parameters available in the literature. That is, estimates are incorporated from empirical research on employer and individual responses to variations in degree of tax exclusion.

    Based on empirical evidence, Gruber makes some assumptions about the insurance-wage trade-off (how saved premium dollars translate into increased wages).

    Any firm-wide reaction, such as dropping insurance or lowering employee contributions, is directly reflected in wages. Yet any individual’s decision, such as switching from group to non-group insurance, is not reflected in that individual’s wages; rather, the savings to the firm (or the cost to the firm) is passed along on average to all workers in the firm. (© 2010 by Jonathan Gruber.)

    Before turning to the implications of reform options, Gruber notes the limitations of his approach. One is worth highlighting:

    If [the] tax subsidy is removed (or mitigated), then healthy workers may find better prices in a more closely experience-rated non-group market, and to some extent abandon the cross-subsidized employer pools. This will raise the price of ESI, which could exert further pressure on healthy workers to exit. This potentially important spiral of rising premiums is not included in the analysis. This effect could be reinforced through the reduced influence of non-discrimination rules that are enforced indirectly through the tax exclusion.

    The concluding section of the paper summarizes simulation results for a variety of changes to tax exclusion policy. Included among them are exclusion cap policies, akin to though not equal to the proposed Cadillac tax.  I won’t review the results much here as there are too many and they are summarized well in tables at the end of the paper, one of which is excerpted below.

    gruber table

    • Gruber’s conclusion that “there is no reason to think that there will be a wholesale exit of medium and large firms from ESI” is suspect, since he himself notes that he is not taking into account the death spiral that would occur if healthier employees begin abandoning the coverage.

      The difference between extensive and intensive margins is an obvious artifact of basing the tax subsidy on graduated income tax rates. The decision to forgo coverage occurs primarily at low incomes, where there are two incentives to decline coverage: (a) a lower tax incentive, and (b) less disposable income with which to afford the employee share of the premium.

      Similarly, I would expect decisions to increase coverage beyond the cheapest offered plan to occur at higher incomes, where (a) higher tax incentives make upgrades appear to be more of a bargain, and (b) there is ample disposable income to pay for the upgraded coverage.

      The Cadillac tax is a poor-to-mediocre way of reducing the intrinsic margin. For people in high tax brackets, it’s merely an incentive to purchase coverage priced exactly at the threshold. Which means you have to be extremely accurate at setting the threshold– too high and you encourage overconsumption; too low and you harm moderate consumers and run into political problems. Since this varies by age, region, and in the case of small employers by number and health of employees, this would require a great deal of micromanagement to set a high-stakes excise tax threshold appropriate to each situation.

      This is only exacerbated by setting the excise tax rate at roughly 100% of the marginal tax rate, which is what a 40% excise tax would do. A 20% or even 10% excise tax would reduce the effective intrinsic margin and discourage overconsumption without the high-stakes consequences of inappropriate thresholds. It would also encounter less political opposition, and might actually raise more revenue than the 40% version.

      • @Bart – Gruber’s estimates are based on variation in progressivity of income tax rates across states and over time. They are not identified by the variation in marginal tax rates across income groups.

        Of course the elasticities are population averages. There is, no doubt, variation in both types of elasticity by income. That could be studied, and in fact may have been (I’d have to look carefully at the literature to remind myself).

    • Also, it would be incorrect to use the current low extrinsic margin to try to predict what would happen if the tax exclusion were repealed entirely. Were that to happen, high-bracket employees would see a greater change in tax incentive than those with low incomes.

      Your concept of extrinsic and intrinsic margins applies only to populations, not individuals. For a given individual, intrinsic and extrinsic are the same (at least under the current system). To predict how high-bracket employees would react to loss of the tax exclusion, you need to look at the high margin.

    • Well, now that I’ve actually read the paper I can see why Gruber is not overly concerned with the assumptions that he himself regards as questionable. He’s not so much interested in absolute accuracy of dollar figures as he is in flushing out relative effects different of policy changes, such as capping the exclusion vs. complete repeal.

      His Table 2, “The Cost and Distributional Implications of the ESI Exclusion” answers questions I have previously had:
      – Median federal income tax rate for individuals receiving ESI is approximately 15% (30% including payroll tax).
      – Median tax subsidy dollar occurs in the 25% federal income tax bracket (40% marginal rate including payroll tax)

      It’s also interesting that he considered capping the exclusion for income tax only, and found that the result was more progressive than capping both the income and payroll tax exclusions. In this case, the median revenue dollar resulting from the change occurs in the decile 9, which may be either the 25 or 28 percent income tax bracket. This corresponds with an excise tax rate of 25 or 28 percent.

      A 10% or 20% excise tax might seem especially reasonable if the proceeds were used to offset the cost of a complementary 20% tax credit (or negative excise tax) for individuals with a below-20% marginal tax rate, in lieu of the tax exclusion.