Wages, assumptions and health with the Cadillac tax

For the past few days, some on the blogosphere have been simmering at the idea of the Cadillac tax, especially the claim that reducing costs of health insurance benefits might possibly result in higher wages.  Of course, opponents of the tax also address things like how bad it is that the Kaisaer Family Foundation's data, assuming average premium growth rate of 8.7% would show that by 2019, family premiums will hit over $30,000.  You should be scared if you are not paying attention to the selective use of the data and bad assumptions here.

So I plan to primarily address a few things today.  First, debunk the idea that one can claim that an excise tax will both force people to choose lower-premium plans and then turn around and say that premiums will still continue to rise at the current rate anyway.  As an aside to that, I will show that even under the status quo, a 5% or so growth rate assumption is not horribly off the marks.  Second, I will show that there is in fact real wage growth possible from the excise tax.  Not in the abstract, but I will demonstrate that health care premiums that employers pay come directly out of your wages.  Lastly, you will see that having a more expensive plan does not make you any healthier or even make you better covered.

ASSUMING THE STATUS QUO & ACTUAL YEAR-OVER-YEAR CHANGE

The first is actually not that hard to show.  There are two parts to debunking it.  First of all, the Kaiser Family Foundation Study - which I have credited as the most comprehensive survey of health insurance plans out there and which some opponents are using to show a dramatic rise in premiums till 2019 - does not, and cannot possibly, take into account what has not been enacted into law yet.  It has to assume the status quo.  They cannot take into account any effects of proposed legislation that may lower costs.

And lower costs is exactly what proponents of the Cadillac tax (including myself) contend will happen.  That is exactly what the 23 economists, including two nobel laureates, who wrote a letter to the White House, contend, put it simply, "The excise tax will help curtail the growth of private health insurance premiums by creating incentives to limit the costs of plans to a tax-free amount."

To the extent that part of one's compensation for labor is taxed (wages), and that other parts are not (health insurance benefits), one is getting a government subsidy in the form of those tax breaks.  The current system incentivizes greater spending on health insurance, and so long as that continues,  costs will be hard to control.  As Ezra Klein explains,
Distilled to its essentials, Herbert is arguing that, even at the high end, more expensive insurance policies are better insurance policies, and that the government should be subsidizing their purchase. Does that sound like a world in which we're going to control costs?

Cost control is based on precisely opposite premises, in fact. First, more insurance is not always better. Health-care outcomes in Canada and England -- both of which have strong pressures against overuse -- are not worse than those in America. More to the point, health outcomes in Kaiser Permanente, which is a managed-care organization, are not worse than those in Aetna's more expensive PPO plans.
When there is an incentive in the system to spend more on health insurance just for the hell of it because you get a tax subsidy, one of the ways to control cost is fairly obvious: limit those subsidies (i.e. the tax benefits).  Once you start controlling the costs of premiums, the assumption that premiums will continue to rise unabated becomes false.  You cannot both argue that the excise tax will force people to choose cheaper plans and premiums will continue to rise at the same rate as under the current system.

Secondly, the Kaiser study also does not merely have average rates of growth in insurance between 1999 and 2009 and that between 2004 and 2009.  It has the the data to show the increase for every one of those years.  You can look it up in their charts, but let me do a little table for your convenience:

YearAvg. Family PremiumYear-over-year change
19995791--
200064387.8%
200170619.6%
2002800313.3%
2003906813.3%
200499509.7%
2005108809.3%
2006114805.5%
2007121065.4%
2008126804.7%
2009133755.4%

Do you see something here?  Doesn't it look an awful lot like that in the early 2000s, rate hikes went through the sky, but the rate of growth drops significantly by 05-06 year-over-year change to around 5%.  And that has pretty much held in the years since.  It is also the longest a percentage growth trend has held in the reported period.  In fact, if you do a weighted average of the last 5 year-to-year increases (i.e. you throw out the biggest and the smallest numbers as outliers), it stands to 5.43%.  So, in fact, I am not so sure that I am wrong in assuming that if nothing changes, the increases will continue to be around 5% rather than 8.7%.

HEALTH INSURANCE PREMIUMS AND WAGES

I believe that there is a fundamental misunderstanding about employer motives, what employers do, etc., when we look at things through the prism of predicting the future.  You all have seen me throw in my lot with 23 renowned economists, including two Nobel laureates, who have advocated for the excise tax, and contended that it would result in real wage growth.  But the most damning case for it lies in this chart that opponents have used to make the opposite point, from the Kaiser Family Foundation:

This chart demonstrates what everyone with any sense on any side of the political debate and policy debate knows: the single biggest reason for wage stagnation is the rise in health care premiums.  This chart demonstrates without question that if health insurance premiums rise fast, then wages do not rise.   Which would make that for wages to rise, health insurance premiums must be held in check.  In other words, we cannot allow health insurance costs to rise if wages are to improve.  The point is, today, even if your employer wants to give you a raise, they cannot because of rising health insurance costs.  If your plan gets less expensive, they may well be able to do so.

It is crystal clear that over the past decade, employers were unable to hand out raises much of the times because of the growth in health insurance premiums.  Which indicates that had they not had to pay the extra premiums, you would have seen a few extra bucks in your pocket.  In fact, this isn't just my option.  The Washington Post reported in March of 2008:
Employees and employers are getting squeezed by the price of health care. The struggle to control health costs is viewed as crucial to improving wages and living standards for working Americans. Employers are paying more for health care and other benefits, leaving less money for pay increases. Benefits now devour 30.2 percent of employers' compensation costs, with the remaining money going to wages, the Labor Department reported this month. That is up from 27.4 percent in 2000.
Once again, there is simply no money left to give you a raise even if your employer wants to, if your health insurance premiums cannot be held in check.

It is in this context that the 23 prominent economists, including two Nobel laureates, the Center for Budget and Policy Priorities, and Ezra Klein, a Domestic and Economic Policy analyst for the Washington Post, the Congressional Budget Office and the Joint Committee on Taxation all agree that the excise tax is a good idea.  And this is the context in which, I once again present the chart of correlation (Credit: Washington Post):

(Credit: Washington Post)

Please notice that the trend that when health care premiums rise faster, wage growth slows or is negative, and when health care premiums rise at a slower pace, wage growth accelerates.  This trend holds true not just for all of the economic ups and downs of the last 20 years.  I don't think it can be dismissed simply as a labor market supply-and-demand issue.  And it's not just a gut feeling.  Ezra explains:
The correlation between the two data sets is -0.8, which is incredibly high for this sort of thing. To give you an idea, I also ran the correlation between GDP growth and median wages over the period: It was 0.7, which is to say that there was a weaker connection between economic growth and median wages than between health-care costs and median wages.

Also, it takes no genius to understand the simple fact that if you happen to have a plan that will be affected by the excise tax, and your employer decides to put you on a less expensive plan, your portion of the premium will similarly decrease.  When your portion of the premium decreases but your total wages do not, it is extra take-home money in your pocket.

HAVING A MORE EXPENSIVE PLAN DOES NOT MAKE YOU HEALTHIER

Let me point out one last thing.  Many people have rightly pointed out that a more expensive plan doesn't necessarily mean better coverage, and thus, families and individuals who do not have good coverage but an expensive plan are likely to be caught into this.  Correct.  But first, this should make everyone wonder if our employers are actually doing the best job negotiating on our behalf.  Second, this also means that a less expensive plan does not necessarily mean worse coverage or make the covered any less healthy (this last point should really be the crucial point).  Having the Cadillac tax, in fact, can make for better care in the lower-premium plans.  David Leonhardt, an columnist on Economic Policy at the New York Times demonstrates this point succinctly:
This tax break causes us to buy more health insurance than we would if the playing field for taxes were level, much as the tax breaks for housing helped inflate the real estate bubble. In effect, the tax-free treatment is a subsidy for health insurers, doctors and hospitals. It encourages wasteful spending — the extra M.R.I., the brand-name drug that’s no better than a generic, the cardiac-stent procedure that has no evidence of extending life (but does have some risk). 
Leonhardt also reports on a little experiment the University of California ran:
In the 1990s, the University of California began charging its janitors, secretaries, professors and other employees a monthly fee for their health insurance plan — unless they chose the least expensive one. Many switched out of the most expensive plans, often to save as little as $10 a month, notes the economist Thomas Buchmueller. The change also led insurers to compete harder for people’s business, improving the quality of the cheapest plans at the expense of the insurers’ profit margins. 
Indeed, people with Cadillac plans are no healthier than those with other coverage:

The most comprehensive study of health insurance, by the RAND Corporation, bears this out. People with Cadillac plans are no healthier than people with Chevy Malibu plans. (Similarly, Americans are no healthier than citizens of rich countries that spend far less on medical care.) “Taking someone who’s uninsured and giving them insurance unambiguously improves their health,” says Jonathan Gruber, a health economist at M.I.T., “but taking someone who’s well-insured and making them really well-insured doesn’t make them any healthier.”
That is it, in a nutshell.

So in conclusion, stop being scared.  Take a deep breath and realize that the world will not end if some form of an excise tax on high-priced employer-sponsored insurance plan is made part of the health care bill that the President signs.  Try to realize that the excise tax creates a downward price pressure on all plans, not just the plans that would be affected by the tax.  Try to realize that you have not been getting any raises, and the most damning reason for that is the way health care premiums have been rising, if you are lucky enough to have coverage at all.  Realize that if your plan happens to fall into this category, the alternative plan will not likely make you any less healthy.

HUGE UPDATE: Paul Krugman Weighs In
Hat tip to Daily Kos comment by weltshmertz on Sat Jan 09, 2010 at 10:10:59 AM PST.

The famous liberal economist, Nobel laureate, and author of The Conscience of a Liberal has weighed in on this debate in his column today.  And he has expressed qualified support for the excise tax.  From his column today:
Should there be a limit to the tax deductibility of employer-provided health insurance, which is what the excise tax in the Senate bill is supposed to fix?

My answer is yes, but the final bill should address the criticisms.
Dr. Krugman addresses some of the faults that critics have raised, saying that "the limit should reflect the same factors insurers will be allowed to take into account in setting premiums: age and region."  I absolutely agree with this.

Paul Krugman then goes on to address the wages issue, saying that he believes there are real trade offs between benefits and wages, even if it can sometimes be exaggerated.  But in the end:
Second, there’s the argument that any reductions in premiums won’t be passed through into wages. I just don’t buy that. [emphasis mine]
He also addresses why:
Maybe it will help the plausibility of this case to notice that we’re not actually asking whether a fall in premiums would be passed on to workers. Even with the excise tax, premiums are likely to rise over time — just more slowly than they would have otherwise. So what we’re really asking is whether slowing the growth of premiums would reduce the squeeze rising health costs would otherwise have placed on wages. Surely the answer is yes. [some emphases mine]
There is no reason for me to elaborate, since I can't do a better job than Paul Krugman.

And lastly, Krugman addresses the union issue:
The last argument is that this hurts unions which have traded off lower wages for better benefits. This would be a bigger issue than I think it is if the excise tax were going to kick in instantly. But it won’t, giving time to renegotiate those bargains. And bear in mind that this kind of renegotiation is exactly what the tax is supposed to accomplish.
Now, Paul Krugman's voice has largely been added to 23 other luminaries in the field of economics, including two other Nobel laureates.  That puts a total of three Nobel laureates on the record as being for the idea of an excise tax on high premiums.