Fringe Benefits and Stagnating Wages
By David Henderson
Former co-blogger Arnold Kling has an excellent post this morning on measurement of worker compensation. He quotes a question from one of his readers. I’ll let you read it for yourself.
Then Arnold answers:
There is a measure of wage growth that includes the cost of fringe benefits, such as health insurance. This is called compensation per hour. There is also a measure that does not include fringe benefits, which is just called wages. Because health care spending has soared, the “fringe” benefits can amount to quite a lot. Thus, the two measures have diverged, with compensation going up more than wages.
Suppose that my salary is $50,000 a year and the employer contributes $15,000 to my health insurance. The good news for me is that the health insurance benefits are not taxed. The bad news is that I might value the health insurance at much less than $15,000.
Arnold also ends with a beautiful rhetorical flourish:
I should add that if somebody insists on not including fringe benefits in their calculations, you might ask them why then one should consider employer-provided health insurance a good thing.
I want to add two thoughts.
My first thought connects the “good news” and “bad news” parts of Arnold’s paragraph above.
Precisely because of the “good news” that health insurance benefits are not taxable to the employee, we can be fairly sure, if employers and employees are optimizing, that employees do value the benefits at much less than the hypothetical $15,000. Why?
It turns out that even though we need to consider the employer’s tax situation to compute the optimal spending on health insurance, we don’t need to consider it to know how the employee values it. So you can skip the next paragraph if you want.
Consider the employer who, even before required to under ObamaCare, provided health insurance for his employees. The vast majority of employees had such coverage. By providing that insurance, the employer saves himself 7.65%: the 6.2% tax on employee pay for Social Security plus the 1.45% tax for Medicare. (Both of these taxes are deductible against employer income and so the net is more like 5%.)
Now consider the employee. Most employees are in a 25 to 31 percent combined federal, Social Security tax, Medicare tax, and state tax bracket. Why? Most lower income employees are probably in a 15% federal tax bracket, a 7.65% S.S. and Medicare tax bracket, and a 2-3% state tax bracket, for a combined total of about 25%. Most higher-income employees are probably in a 25% federal tax bracket, a 0% S.S. bracket, a 1.45% Medicare bracket and a 4 to 5% state tax bracket, for a combined total of about 31%. Let’s use the mid-point of 28%.
The health insurance benefit of $15,000 is worth about $10,800 to employees on average. I computed this by applying the 28% marginal tax rate to the $15,000.
Of course, if it’s the optimum (from the employers’ and employees’ perspective, not from society’s perspective, because the tax treatment leads to over-insurance), there will be employees who value it less and employees who value it more.
My second thought is that, as the letter writer to Arnold noted, there are other fringe benefits. One big one, that has grown in the last few decades, is employer contributions to 401(k) and 403(b) pension plans. My employer contributes 5%. That’s a big number.