Sunday, March 8, 2009

Health Care Reform and Supply-side Arguments

Greg Mankiw and Sally Pipes note what CBO director Doug Elmendorf said about the use of a supply-side argument by Democratic proponents of health care reform:

The point is that for employers, health care is merely a part of total compensation: It reduces cash compensation for employees but it does not increase costs of employment. To argue otherwise is to argue for lower total U.S. compensation -- that is, lower wages for U.S. workers. Said Mr. Elmendorf, "the costs of providing health insurance to their workers are not a competitive disadvantage to U.S.-based firms."

If one assumes that the labor supply curve was perfectly inelastic, then any increase (decrease) in the amount of employee health care cost borne by the employer would be fully passed onto employees in the form of lower (higher) wages. The analysis is similar to an analysis of the effect of reducing the payroll tax - a proposal that Greg Mankiw has made. If the labor supply curve is perfectly inelastic, reducing either the payroll tax or the amount of employee health care cost borne by the employer would have no effect on the cost of employment to employers or the amount of workers hired.

But wait a second - I thought moderate supply-siders such as Greg Mankiw (Dr. Mankiw is not one of those lunatic supply-siders like Art Laffer) argue for reductions in the payroll tax in order to induce an increase in employment as if the labor supply curve were not perfectly inelastic. So why wouldn’t a reduction in the amount of employee health care cost borne by the employer have at least modest benefits for the US economy?

Update: CBO provides Elmendorf’s testimony on February 25, 2009. On the last two pages of this 31 page document, there is a brief discussion entitled “Effects on the Economy”. While Elmendorf did make the sensible statement that any cost of employer provided health care would at least be borne in the form of lower wages, this section also begins with:

Proposals that made large-scale changes affecting the provision and financing of health insurance could also have an impact on the broader economy. Because most health insurance is currently provided through employers, proposals could affect labor markets by changing individuals’ decisions about whether and how much to work and employers’ decisions to hire workers.


Anonymous said...

Regardless of who bears the cost our health care system is grossly inefficient. Trimming 8% off the cost of employment with single payer would give a great improvement in competitiveness.

ProGrowthLiberal said...

Anon - the Elmendorf-Mankiw-Piper view is that if we cut the cost of this health care by 8% of the cost of employment, wages would rise by 8%. While no improvement in the unit labor cost in their NON-supply-side model, I would suspect a lot of workers would love to see real wages go up by 8%.

Anonymous said...

But would, in the real world, many employees see their income go up 8% or would the employers keep the 8% themselves? My guess would be the companies would keep the 8%, as the workers have close to zero leverage.

is there not sufficient evidence for this question to be answered without resorting to models?

Bruce Webb said...


Sorry these people do not live in the real world. Even today there are probably tens of millions of people who have been working for the same employer for five or more years. And not coincidentally are working under various types of contracts that limit the employer's ability to just adjust pay outright. For the most part those employers have been seeing the cost of their health care plans go up and up. Certainly they try to pass some of that cost on to employees in the form of higher co-pays and deductibles or in the form of more contributions on the front end but in a lot of cases they just have to eat the cost for those workers who contracts protect them. For example their executive suite and. between contract negotiations, their unionized employees.

The argument that "health care does not increase cost of employment" is simply a text book conclusion based on a mythical world where all compensation is a matter of negotiation between a single employer and a single employee based on an evaluation of the former on exactly how productive the latter is likely to be and where subsequent compensation is simply adjusted for actual marginal productivity.

Well in the real world not everyone is an 'at will' employee, in fact most people start work 'at scale' and earn take home increases on the basis of a combination of longevity and COLA. If the above argument were true than increases in health care costs would end up as real decreases in real take home pay for everyone. Well normally that simply doesn't happen, between actual contractual obligations and the realities of trying to recruit and train replacements at the now newer lower wage employers have to find some other way of compensating for the increased, yes increased cost of employment. This can take many, many forms: attempts to ration office supplies, cutting back on the employee holiday party, taking the thermostat down a couple of notches in the winter. But if we had to take the most common form of action it would be trying to raise productivity via time management, that is strictly monitoring such things as arrival, departure and break times and limiting time wasting activity like internet browsing and e-mail.

That health care is carried on the books as 'employee compensation' and heating the cubicles is considered 'operating costs' is just a book-keeping convention, the idea that employees paychecks are frictionlessly exposed to changes in health care costs but totally inelastic when exposed to changes in the cost of paper clips is just not reality. Instead total labor costs are controlled by everything from software per-seat licenses to property tax and square foot lease rates for the office space or warehouse.

Somehow these guys have elevated a bookkeeping convention to an economic law.

I live in the Seattle area and a lot of the cutting edge hi-tech firms have a policy of providing free or subsidized food courts and game rooms. Microsoft even has its own bus service to take employees across Lake Washington to and from Redmond and Seattle. These are definitely labor costs and for all I know carried as such on the books. The idea that such cost do not increase the cost of employment or are automatically offset in the form of wages is pretty nutty. Yet when you replace 'free food' or 'free transportation' with 'free health care' suddenly the equation just changes.

Sorry not buying, these guys have simply sliced away all reality to smooth their model.

Egy Azzierah said...

With various health care reform bills floating around both the House and the Senate, President Barack Obama is pulling out all the stops to get the votes that the bill needs, which is good news for the public option. President Obama continues to rally behind health care reform. I am really concerned that the fiasco of this reform may make Obama a one-term president. said...

IMHO, in the western medicine world, we have lost touch with the basic concept of true healing. We substitute a band-aid for a cure and wonder why we don't feel better. People need holistic approach, money wise, we find prosperity and health intertwined.

Büyüler said...

IMHO, in the western medicine world, we have lost touch with the basic concept of true healing. We substitute a band-aid for a cure and wonder why we don't feel better. People need holistic approach, money wise, we find prosperity and health intertwined.