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Friday, November 6, 2009

The Healthcare Bill and the Poor by Dr. Douglas O. Walker

It is not easy to help the poor and the lower middle-class through public policy.

Almost always, efforts by government to do so end up adding to the burdens on the poor and putting obstacles in their way to a better life. For this reason, measures intended to lift their incomes and provide them with services must be carefully crafted to ensure that they do not do more harm than good.

An example is the health care reform bill now being discussed in Congress. At the present time, there are several versions of the bill making their way through Congress and contention over the drafting of the bill is high, so it is not clear exactly what the final bill will look like. One idea being discussed is providing subsidies for health insurance to low-income individuals and families. In a recent blog entry, Professor Gregory Mankiw of Harvard focused on one aspect of the Baucus bill recently passed by the Senate Finance Committee and pointed to one of many problems hidden in the approach to subsidized health care in the bill.
Here the problem before the policymakers trying to help the poor afford health insurance with means-tested subsidies: Because the cost of comprehensive health care is expensive and beyond the ability of low-income families to afford full coverage, the bill proposes subsidizing its cost to low-income families, and the poorer the family, the greater the subsidy.

There is no problem with a subsidy if the family remains poor and its income does not change. In this case, the subsidy continues unchanged. However, means-tested subsidies do affect incentives to work and earn more income. If the family earns more income, for example, its subsidy is reduced, and the cut in the subsidy falls faster than the rise in the family’s income until the family’s income has risen to the point where it no longer qualifies for a subsidy.
On first appearance, this seem fair since low-income families should be subsidized more than high-income families, and at some point the subsidy should end.
Now we ask the question, "How does the reduction in the subsidy affect the family's income if the family works harder and earns more income? In other words, if the family’s income rises, what happens to the taxes and fees it must pay to the government.

In the case illustrated by Mankiw, he points out on the basis of the provisions of the Baucus bill if a family earning $54,000 receives a $12,000 increase in pay its health care insurance premium increases by $2,800, or about 23 per cent of his pay raise. This also sets in motion other changes to the family's tax obligations:

A higher pay check means higher Federal income taxes. A family earning $54,000 a year is in a 25 per cent marginal tax bracket. 25 per cent of the addition $12,000 means $3,000 in extra Federal income tax.

It also means higher Social Security and Medicare contributions of 7.65 per cent (actually, double this figure, since the employee pays the employers share in the form of lower wages, not considered here). This amounts to a deduction of another $918 from the $12,000 pay raise. So far, the government has taxed $6,718 out of the $12,000 raise.

But there are yet more taxes. Here in Virginia we have a state income tax. The additional tax attributable to a pay raise that lifts a family’s income by $12,000 from $54,000 a year to $66,000 a year generates another $788 in tax owed to the state of Virginia.

Even this is not the end of it. Virginia has a general sales tax rate of 5 per cent (4 to the state, 1 to the city). If the family decides to spend the approximately $4,500 left after paying the mandatory health care insurance premium, the Federal income tax, the mandatory Social Security and Medicare contributions, and the state income taxes, another $225 will have to be paid in sales taxes.

And there is yet more. Embedded in the price of all products purchased are taxes and fees paid by producers, from the corporate income tax to property taxes on commercial property to the import tariffs and duties on goods and services imported into the country. These taxes are either shifted forward to the consumer or backward to the factors employed. A good estimate of these added costs to the consumer is another 5 per cent of their additional consumption expenditures, or another $225.

Given all these deductions for taxes and fees, the actual amount of additional purchasing power to the example family from a $12,000 raise in pay is only about $4,000, or one-third of the supposed increase their increase in income.

In other words, provisions of the Baucus bill cause the government to take two-thirds of any additional income of a family with a modest income of $54,000. Similar results in terms of percentages would occur at lower levels of family income.

It is of course important to extend access to health care to all segments of the population. But how this is done is the critical question. It is not enough to simply put out a program without considering its unintended consequences. Often attempts to help people through public policy end up setting them back.

As now written, the Baucus health care reform bill is an example. It leads to confiscatory rates of taxation on families of modest incomes. Marginal rates can be even higher, it should be noted, on families with higher incomes in some versions of the health care bill now under discussion.

The problems go beyond a poorly designed health care bill. The simple fact is the high general level of taxation in this country has reached the point of oppression, especially on the poor, because implicit tax rates on the poor are much higher than those on the wealthy.

Means-tested provisions of income and services to the poor often create 'poverty traps' that make it difficult for the poor to raise their after-tax income. In doing so they discourage work and lead to efforts to hide income and earn income off-the-books, often through illegal activities. Health care legislation now being considered by Congress is a perfect example of the unintended consequences of poorly thought out public policy.

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