Taxing Higher Earners and Subsidizing Lower Earners Would Reduce Inequality
In a recent paper for the University of Chicago’s Becker Friedman Institute, MIT health economist Amy Finkelstein and three colleagues point out the obvious: taxing higher income people and subsidizing lower income people would reduce inequality.
Specifically, they examine what would happen if the U.S. government nationalized the financing of employer-provided insurance, paying for the insurance with a hefty payroll tax. Here’s their abstract:
Over half of the U.S. population receives health insurance through an employer, with employer premium contributions creating a flat “head tax” per worker, independent of their earnings. This paper develops and calibrates a stylized model of the labor market to explore how this uniquely American approach to financing health insurance contributes to labor market inequality. We consider a partial-equilibrium counterfactual in which employer-provided health insurance is instead financed by a statutory payroll tax on firms. We find that, under this counterfactual financing, in 2019 the college wage premium would have been 11 percent lower, non-college annual earnings would have been $1,700 (3 percent) higher, and non-college employment would have been nearly 500,000 higher. These calibrated labor market effects of switching from head-tax to payroll-tax financing are in the same ballpark as estimates of the impact of other leading drivers of labor market inequality, including changes in outsourcing, robot adoption, rising trade, unionization, and the real minimum wage. We also consider a separate partial-equilibrium counterfactual in which the current head-tax financing is maintained, but 2019 U.S. health care spending as a share of GDP is reduced to the Canadian share; here, we estimate that the 2019 college wage premium would have been 5 percent lower and non-college annual earnings would have been 5 percent higher. These findings suggest that health care costs and the financing of health insurance warrant greater attention in both public policy and research on U.S. labor market inequality.
The paper is Amy Finkelstein, Casey C. McQuillan, Owen M. Zidar, and Eric Zwick, “The Health Wedge and Labor Market Inequality,” Working Paper No. 2023-50, April 2023. McQuillan and Zidar are at Princeton University and Zwick is at the University of Chicago.
Notice in the first sentence their reference to the current way of financing employer-provided health insurance as a “head tax.” My guess is that they want people to think that the current way of financing is kind of like a tax but their intellectual honesty requires them to put the term in quotation marks. Because, of course, it is not a tax.
The payroll tax that they consider is large: 11 percent. They write:
For our baseline analysis (with τ = $7, 758), we calculate that the counterfactual, equilibrium payroll tax t would be 11 percent. That is, switching to payroll tax financing would add an additional 11 percent to existing payroll and income tax rates.
That second sentence is incorrect. Adding an 11 percent payroll tax would not add “11 percent to existing payroll and income tax rates.” It would add 11 percentage points, a different matter indeed.
Interestingly, in their abstract Finkelstein et al. note that with such a tax replacing the current system, “non-college employment would have been nearly 500,000 higher.” That makes sense. But wouldn’t college employment be lower? Yes, it would. On page 8 of their Appendix, they point out that college employment would fall by 371,593, non-college employment would rise by 457,288 and total employment would rise by only 85,696. But they don’t seem to think that although an increase of nearly 500,000 jobs for workers who are not college graduates is worth mentioning in the abstract, a loss of “nearly 400,000 college jobs” is not.
Their analysis is positive, not normative. So one can’t necessarily conclude that they are advocating such a hefty payroll tax. My guess is that they are, though. One reason I think that is that they quote, without commenting, Emmanuel Saez and Gabriel Zucman’s statement that the current system of employer/employee financing “is the most unfair type of tax.”
They do point out how huge a bite health insurance takes out of pay, especially for workers without a college education:
Average insurance premiums for employer-provided health insurance were about $12,000 in 2019. This amount is about 25 percent of the average annual earnings for a full-time, full-year worker without a college education (about $50,000), and about 12 percent of the average annual earnings for a full-time, full-year college-educated worker (about $100,000).
That 25 percent number is shocking but true. Of course it’s possible that the average worker gets large value from these expenditures. But the authors don’t address that.
Are there other ways of making health insurance cheaper by making health care cheaper? There are. The federal and state governments could deregulate supply, allow more immigration of doctors, and get rid of the requirement that a doctor be a middleman for prescription drugs, as is done in some other countries. Unfortunately, the authors consider none of these ways.
The second-last sentence in their abstract is interesting. Why mention reducing health care spending as percent of GDP in the United States (16.8 percent in 2019) to the much lower percent in Canada (10.8 percent), a reduction of 37.5 percent, unless the authors are treating as a serious option the imposition of Canadian-style rationing?
Note: The Becker Friedman Institute is, of course, named after Gary Becker and Milton Friedman.