Premium-wage tradeoff literature review: The public sector

The following is cross-posted at the HealthCare Markets and Regulation (HMR) Lab, Department of Health Care Policy, Harvard Medical School and is by Jeannie Biniek, a PhD candidate in the economics track of the Health Policy Program at Harvard University. From 2009 to 2013 she worked as professional staff for the Senate Budget Committee where she advised Chairmen Murray (D-WA) and Conrad (D-ND) on health, tax, and economic policy issues. Prior to that she worked as a consultant to companies in the health care industry on transfer pricing matters and intellectual property litigation. She holds a BA from the University of California, Los Angeles and a MA from Johns Hopkins University. This is the first of three posts. The other two are here and here.

Last month, Austin Frakt promised to carefully go through the econ literature on the premium-wage tradeoff. (I’m sure he intended to follow through, but I offered to take on this task so he didn’t have to.) First, he said he would identify studies examining public sector employees. Is there a reason to expect something other than a 1:1 premium-wage tradeoff in this setting?

Following his plan, I found four papers on this topic:

Eberts and Stone have the only finding anywhere near a 1:1 tradeoff, with wages falling by 83 cents for each dollar increase in health insurance premiums. The more recent analyses estimate between 15 and roughly 50 percent of the cost of rising health insurance premiums are passed on to workers. Together, these studies identify two potential explanations for why we don’t observe a 1:1 premium-wage tradeoff in the public sector.

First, the public sector is not in competition to the same extent as private firms. In particular, where public sector employees are unionized, and in particular where those unions leverage public sector employees’ position as the monopoly providers of government services, we may see some sharing of the risk between employees and employers of uncertain year-to-year changes in health insurance costs. If this is the case, when health insurance costs grow during a given contract period, the terms of the contract may require the government to bear at least some of the burden of those costs.

The literature supports the notion that unionization and union strength matters. For example, Clemens and Cutler find that where teachers’ unions are stronger, school district employees bear a smaller share of the cost of higher health insurance premiums. Instead, total compensation increases overall when health insurance premiums grow.

With each new contract, however, Lubotsky and Olson point out the following:

[U]nion and district compensation negotiations will set the union’s marginal rate of substitution between wages and benefits equal to the district’s marginal willingness to trade-off benefits for wages. A unionized setting does not itself imply that the trade-off between wages and insurance vanishes. A strong union will bargain to increase total compensation, but will also be willing to trade-off health insurance for salary.

Limiting their analyses to the first year of each school district contract, Lubotsky and Olson find that school districts appear to bear some burden for changes in health insurance costs. They discuss a second explanation for this finding — the idea that health insurance for public employees is a “shrouded” benefit (Clemens and Cutler also include a discussion of “shrouded” benefits). This view argues that because the cost of fringe benefits (such as health insurance and pensions) is less salient to voters than wages, public officials competing for votes opt for compensation packages that weigh more heavily toward these benefits.[1] As a result, workers value the additional health insurance benefits less than the cost to provide them, and so, they are unwilling to accept dollar-for-dollar lower wages when the cost of health insurance benefits grow.

Ultimately, therefore, it’s not surprising to find something less than a 1:1 tradeoff of wages and premiums in the public sector. I will consider literature that focuses on the private sector in subsequent posts.

[1] Glaser and Ponzetto (2014) introduced the idea of “shrouded” benefits in the context of public employee pensions, adapting Gabaix and Laibson’s (2006) “shrouded attributes”.

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