Monday, April 25, 2011

Obamacare’s Perverse Incentives for Work — And Taxes

Daniel Kessler’s op-ed in this morning’s Wall Street Journal concisely makes the argument why the structure of insurance subsidies in the new health care law will reduce incentives to work.  Specifically, earning as little as $1,000 in income could cost a family more than $10,000 in insurance subsidies, due to what Kessler calls the “notches” at various income levels (a family at 399% of poverty gets a generous subsidy; a family with income of 401% FPL gets nothing).  The Congressional Budget Office agrees with this analysis, noting last June that “the phaseout of the subsidies as income rises will effectively increase marginal tax rates, which will also discourage work;” CBO’s best estimates are that 800,000 fewer jobs will exist thanks to the law’s perverse incentives.

There’s a related story here as well, and that’s this:  At a time when both Democrats and Republicans have talked about simplifying the tax code, the health care law substantially increased the economic distortions being funneled through it.  While the devilish details remain in flux, many observers in both parties support (at least in theory) reducing tax rates by eliminating tax expenditures.  Many economists agree that those tax expenditures, in addition to making the tax code more complex, also increase economic distortions, by subsidizing certain activities (e.g., buying hybrid cars) or by encouraging individuals to take other actions that they would not have engaged in absent an explicit federal subsidy.  The health care law does much the same thing – it encourages people NOT to work, or to funnel income into other activities (e.g., increasing 401(k) contributions), to report lower adjusted gross income and thus qualify for insurance subsidies.  That the abrupt phase-out of the insurance subsidies leads (at the “notches” at least) to an effective marginal tax rate of over 100% – as little as an extra dollar of income could cause a family to lose over $10,000 in federal insurance subsidies – makes the effect that much more acute.

President Obama claims he wants to simplify America’s tax structure, but by funneling the insurance subsidies through the tax code, the health care law he signed takes a major step in the opposite direction.  At a time when the economy faces continued sluggish growth, the last thing it needs is the distortionary effects of these ill-designed policies.