This Alert is based on the Reid bill as of yesterday. If last night’s agreement pans out, I’ll have more to say about that in a future Alert.

When Barack Obama campaigned for president, most people thought they heard him say three things: (a) the federal government should help the 47 million uninsured Americans get insurance, but (b) people who already have insurance have no reason to worry because “if you like the insurance you have, you can keep it,” and (c) in paying for this program there will be no tax increases or benefit cuts for the middle class. 

The bill the Senate is debating this week is night-and-day different.  

Let’s Call the Whole Thing Off

At best it will insure only half the uninsured and this estimate is probably too optimistic, given the very fluid nature of uninsurance (see here and here). Up to one out of every four seniors will either lose the plan they now have or experience cutbacks in benefits; and millions of nonseniors will be pushed out of their employer plans and into either Medicaid or a government-regulated health insurance exchange. In violation of another Obama promise, millions more will be forced to switch to more expensive, bloated coverage that they may not want or need. This program is turning out to be more expensive than anything candidate Obama ever hinted at; and it will be mainly paid for by tax increases and benefit cuts imposed on the broad middle class.

To add insult to injury, this new program will not solve the three problems candidate Obama said most need solving: (a) the cost of health care will be higher than otherwise, according to every single estimate in and out of government, (b) the quality of care will be threatened by new, payer-imposed constraints in an attempt to stop the relentless rise in costs, and (c) after spending trillions of dollars, access to care for most Americans may get worse, not better.

Small wonder that polls show the public is against this bill. Phone and e-mail messages to Congress from those “against” are many multiples of those “for.” And who can blame them?

Under the 2,074-page bill, everyone will be required to have health insurance and, for most people, the insurance will be very expensive. In 2016, for example, the minimum coverage is projected to cost:

Individual:           $5,200 plus $1,900 of potential deductibles and copayments

Family:    bl         $14,100 plus $5,000 of potential deductibles and copayments

If you do not get insurance from an employer, you will be required to buy in an “exchange,” where there will be government subsidies for those who earn between 100% and 400% of the government poverty level. These subsidies can be quite large. For a family earning $30,000 the (premium plus out-of-pocket) subsidy is $16,800 — an amount equal to more than half of the family’s income! At $42,000 income, the subsidy is $13,500.

As was the case with the Baucus bill, which this bill replaces, here’s the problem. There are 127 million nonelderly Americans living between 100% and 400% of the federal poverty level. Yet the Congressional Budget Office (CBO) projects that only about 18 million will be in the exchange getting subsidies.

So what happens to everyone else? They will have to bear the cost on their own (through out-of-pocket premiums and reduced wages) without any new help from government.

And what if people don’t buy the insurance they are required to buy? They will pay a (2016) fine of $750 (individual) or $2,250 (family) — a tempting alternative considering that if they get sick and really need insurance, insurers will not be allowed to deny them coverage or charge them a higher premium at that point.

Technically, your employer does not have to provide insurance to you and your family. But if not, and if you go into the exchange, your employer will face a fine (tax) that will be the lesser of:

1. $3,000 for each employee getting a tax credit (government subsidy) in the exchange, or
2. $750 for each full-time employee, whether or not they are in the exchange

Let me make four quick observations.

First, let’s combine the interests of the employee and the employer and ask whether it makes sense to be in the exchange or outside of it. One way to think about this problem is to recognize the fact that no one has to pay below 19% of family income for insurance that costs $14,100. So the question under alternative (1) is: Is the subsidy in the exchange greater than the $3,000 fine that must be paid for employees who enter it? For anyone earning less than about $58,000, that turns out to be true. Whether alternative (2) is cheaper depends on how many employees enter the exchange. Suppose they all do. Their fine is worth paying so long as average employee income is less than about $70,000.

Second, alternative (1) is likely to be cheaper for companies with lots of highly paid workers and a few low-paid ones. Since IBM’s high-income employees will not qualify for any subsidy in the exchange, the company would be better off sending its groundskeepers, maids and custodians to the exchange and paying $3,000 for each one of them rather than paying $750 for every employee. By contrast, a maid service with lots of moderate-income employees and very few highly paid ones would be better off sending everyone to the exchange and paying the $750-per-employee fine.

Third, depending on the employer’s labor profile, these alternatives have radically different hiring implications. If the first alternative turns out to be cheaper, employers will face a $3,000 annual tax on each new, moderate-income employee. If the second alternative is cheaper, the annual tax on each new hire will be $750.

Finally, the tax law adds two more wrinkles to these considerations. Although employers can deduct premium payments, they will not be able to deduct the fines. This means that the effective cost of a $750 fine is closer to $1,000. The effective cost of a $3,000 fine is closer to $4,000. Another consideration is the current practice of excluding employer-paid premiums from the employees’ taxable income. This exclusion is more valuable as income rises and employees reach higher tax brackets. Within the exchange, however, the size of the subsidy falls as income rises.

It’s hard to believe we are even considering such a Rube Goldberg approach to health insurance. But since we are, what are the likely consequences? Here are the first ten that come to mind:

1. Millions of jobs lost. Economic theory teaches that employee benefits and/or labor taxes are substitutes for wages. Eventually, employees pay for their benefits with less take home pay. No doubt in the long run this is true. In the short run, however, the employer of a $30,000 uninsured employee under alternative (1) either has to endure a one-third increase in labor costs or cut his employee’s paycheck by one-third. I believe the short-run response is likely to be unemployment. For a state such as Texas — where 30 percent of working-age adults are uninsured — the economic effects will be devastating.

   As employers and employees adjust to the new health insurance regime (in ways described below), politicians are unlikely to sit idly by. They will meddle more and more. So for almost every employer, the likely future is higher labor costs. As in Europe, employers will try to avoid new hires wherever possible. In any sector that relies on low- and moderate-wage labor that must be supervised on-site, jobs will be permanently lost. Many will go offshore.

2.  Major industrial restructuring. The CBO is not being creative enough in estimating that only 18 million people will enter the exchange. If you have lavish subsidies in one sector and draconian taxes in the other, people will find a way to exit the latter and enter the former. For example, wherever possible, people will become independent contractors — doing work that could be done by employees in a way that is not counted as “employment.” That way, people can take advantage of subsidies in the exchange without any reduction in wage income.

   To return to IBM, the ideal solution is to fire all its low-paid workers and contract with outside firms for their services. Newly-created firms could offer grounds keeping, maid, custodial and other services and send all the employees to the exchange for a $750-a-piece fine. More generally, we would expect low-income employees to congregate in firms that specialize in hiring them and selling their services to other firms.

3. Emergence of niche markets. Any head of family earning up to $24,000 in 2016 will qualify for Medicaid. And (ironically), employers will not have to pay any fine if they don’t provide insurance to employees who enroll in Medicaid. So low-paid workers will look attractive to employers, so long as they remain low-paid. After a $1 raise, however, if the employee seeks highly subsidized (and probably much better) insurance in the exchange, the employer will get hit with a fine. So employers in these markets will survive only by keeping a lid on their payrolls. We can also imagine niche market firms employing spouses, live-at-home teenage workers and anyone else who is getting insurance through another family member. Niche market firms could also emerge, hiring part-time employees (less than 30 hours per week), for whom there are no fines or penalties.this text should not appear this text should not appear this text should not appear
4. Very high marginal tax rates. Since the subsidy within the exchange phases out as income rises, it creates a penalty on higher earnings that operates just like a tax. As family income increases from $30,000 to $54,000, for example, the decline in subsidy is almost 28% of the income increase. When added to a 15.3% (FICA) payroll tax and, say, a 15% income tax, this pushes the overall marginal tax rate to 58% for below-average-income workers! And this is without even considering the effects of phasing out the Earned Income Tax Credit (EITC) and other welfare benefits. These high tax rates will strongly discourage reported income.this text should not appear this text should not appear this text should not appear
5. Higher insurance premiums. Insurers will be required to sell to all comers (guaranteed issue) and charge everyone of the same age the same premium (modified community rating). These restrictions encourage people to remain uninsured (paying a $750/$3,000 fine if it is really enforced) while they are healthy, secure in the knowledge they can always buy coverage after they get sick. The result: premiums for those who do insure will be much higher than otherwise. In contrast to the CBO, a Blue Cross study based on real actuarial data estimates premiums will be 54% higher in the individual market and 20% higher for small businesses. Also as previously reported, studies by BlueCross, WellPoint, the insurance industry trade association (AHIP) and every other public and private study are all predicting soaring premiums — a 50% average increase by one estimate and premiums tripling for the young and the healthy by another.

   And the results could be much worse. We previously reported that in New York’s individual market, premiums are $9,036 for singles and $26,460 for families. In Massachusetts, Harvard Pilgrim reports that people are signing up, getting their surgery and then dropping coverage again.

6. Fewer insurance choices. Although advocates of health insurance exchanges tout the advantages of competition and choice, there are likely to be far fewer choices in the exchange than there are in the individual market today. In New York, for example, all the commercial carriers have left the market — leaving only BlueCross as the monopoly insurer!
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7. Higher than anticipated taxpayer costs. As with all the other health reform bills on Capitol Hill, the Reid bill engages in budget shenanigans, designed to disguise the true cost of health reform. For example, the bill starts collecting new and higher taxes next year; but the new benefits don’t start kicking in until year five. Once the spending begins, the first ten-year cost is at least $2.5 trillion.this text should not appear this text should not appear this text should not appear
8. Fewer than anticipated people insured. Beyond that, the CBO is under-estimating how much people will reorder their behavior in the face of the perverse financial incentives described above. Where there are lavish subsidies to be had, people will find ways of having them and this can occur even without any reduction in the number of uninsured. As Martin Feldstein has pointed out, the Reid bill makes being uninsured a very attractive proposition for healthy people.this text should not appear this text should not appear this text should not appear
9. New unfunded liabilities. The Social Security/Medicare Trustees reported last spring that the combined unfunded liability in the two programs is $107 trillion — almost seven times the size of the U.S. economy. These obligations will get larger. Even without “reform,” the number of people covered by Medicaid and the State Children’s Health Insurance Program (S-CHIP) will be 76 million by 2019. With “reform,” the number will reach 90 million.

   Employers will be indirectly required to provide health insurance for which employees nominally pay no more than 10.2% of income. Within the exchange, the maximum cost (for the minimum required insurance) will be capped at between 8% and 19% of income. And here is the problem with that: For the past 40 years health care costs have been rising at twice the rate of growth of income and there is no reason to expect abatement.

   So either health insurance costs will take more and more of family income (as the legislation now reads), or government subsidies will close the gap — meaning that taxes will take more and more of family income. If the recent response to Medicare costs for seniors is any guide, the taxpayers will be stuck with a larger liability than anyone is now estimating.

10. Exacerbating the problems of cost, quality and access. The Reid bill will increase demand, but it will do nothing to increase supply. This almost certainly will lead to higher prices and more health care spending. As previously explained, there are no realistic offsetting provisions for controlling health care costs.

    Also as previously explained, the perverse incentives of managed competition will encourage health plans within the exchange to underprovide care to the sickest enrollees.

    Even if the number of people who are nominally insured rises, access to care may actually decrease. As demand increases and supply does not, the waiting costs of care will rise for almost everyone and the money cost of care will rise for most people. (Remember: The vast majority of people are getting no new government subsidy.) Massachusetts cut the number of uninsured in half. But waiting times to see a new doctor in Boston are twice as long as in any other U.S. city and the number of people seeking nonemergency care at hospital emergency rooms is as high today as ever.

Worst of all, not only will “reform” not solve any of the problems it is supposed to solve, it will almost certainly undermine the ability of entrepreneurs in the private sector to solve them.