Obamacare: More a Working-Class Trap than a Poverty Trap

by Patrick Brennan

It’s now widely understood that Obamacare will reduce the number of Americans working, and the amount of work they do, relative to what these figures otherwise would have been. But which Americans, and why? A lot of them will be working less because of an increase in implicit marginal tax rates, because the ACA’s subsidies for health insurance drop with income. What does that actually mean?

In an excellent post, former Bush economic adviser Keith Hennessey lays out one of the scenarios: a family of four with one working parent, making $35,300 a year. Under the ACA, if they don’t have access to a health plan, they can buy a silver-level insurance plan (a little more expensive than the cheapest they can get, but a popular choice) for about $1,410 a year.

If the second parent — call her Julia — decides to take a part-time job that will pay her $12,000, their premium will rise by about $1,500, to around $3,000.

That cut to Julia’s tax credit is effectively a 13 percent tax on the $12,000 in income she earns on the side.

That isn’t so bad, right? It is when you add that 13 percent tax rate to the effective marginal rate this family already faces: 37 percent (in part because other tax credits are phasing out at that level, in part — there are other “traps” that extend into the middle class). They lose, in other words, half of every extra dollar they earn, and one-quarter of those losses are due to Obamacare.

Is it worth taking the job, taxed at a 50 percent effective rate?

Maybe, maybe not. It actually could cause Julia to take on a job that pays better or work even more hours, to offset the effective income losses, but it may make her decide that leisure or taking care of her kids is preferable to taking a job that will only net the family’s bank account just 50 percent of the salary she earns. The CBO’s calculation suggests that the latter will outweigh the former substantially, to the tune of people forgoing 2 million full-time jobs’ worth of work in 2017 than they’d otherwise do. (There are obviously people in different situations — including some poor people — who will forgo work because of the law, too, but Julia definitely represents a big one.)

And in ways the CBO can’t entirely account for, Hennessey notes, this isn’t just about working more or less:

Note also that this subsidy phaseout doesn’t only discourage additional work, it discourages anything that increases one’s income, including additional job training, education, or even a promotion to a better-paying job. The marginal benefit one gets from any of these income-increasing opportunities is smaller because the government “claws some of it back” by reducing the generous ACA premium subsidies as one’s income grows.

Now, the family earning $35,000 a year will be materially better off under the ACA (though a lot of the large tax subsidy they’re getting is not valuable to them if it’s going to pay for a more comprehensive insurance plan than they’d want).

And because the marginal tax rate isn’t 100 percent, they’ll be materially better off if Julia takes that job anyway. But because she’s less likely to, the economy as a whole is almost certainly going to be worse off. It’s also not, as some Democrats have argued, “enabling” the second earner to stay at home — though of course some people will be “enabled” to work less than they would have had to because of the benefits of Obamacare. Many more, the CBO calculates, will not work as they would have chosen to otherwise because the government will effectively yank back half of their salary.

And in the long term, of course, the benefits of working part-time, investing in one’s skills to earn more, or finding a higher-paying job are going to pay off much substantially enough to make it well worth it, even when it’s for a smaller income increase than they would have gotten pre-ACA and too small an income to make it desirable in the short term (Tyler Cowen has more on this unfortunate disconnect). Reducing the returns to working is definitely a bad idea for the economy in the short term, and in the long term, probably a net loss for the person – which is why we want public policy that encourages work, not discourages it.

Of course, some people leaving the labor force because of Obamacare are doing so for another reason: Because their incomes have been increased enough by it that they don’t need to work or can work less. This can be a good result in some instances – with single mothers, for instance, though many of them are already covered by Medicaid and S-CHIP (another example would be people who can afford to go to school and work part-time, say, confident they can receive subsidized insurance — that’s a useful thing to encourage). In some cases, it’s a nice thing for the person but an essentially pointless, if not costly, social goal.

Just how many Americans will face the above tradeoffs? They extend well into the middle class, well beyond people making, say, $35,000 like the ones above: 39 percent of Americans earn too much to be eligible for Medicaid but less than the income limit for subsides, which is $94,000 for a family of four. All of the people at those income levels who don’t get insurance through an employer (a population that will expand significantly over the next ten years) will now see their effective marginal tax rates increased. The working and the middle class without employer health insurance will be substantially discouraged, at the margins, from earning more income — ascending into or through the middle class — because of the ACA.

The CBO doesn’t talk about who’s going to be dropping out of the labor force for the reason discussed above, but it seems reasonable to conclude that many of those affected will be second earners — primarily women — for a variety of reasons. Families and older people (over the age of 50, say) will have the most reason to adjust their behavior because of the ACA’s effect on marginal tax rates, because they’re getting the biggest subsidies. More than 2 million people will be reducing the work they do, the CBO notes, since the overall effect (they think) will be 2 to 2.5 million full-time equivalents. As I’ve explained, the above is a pretty substantial work disincentive in the ACA — but there are others, and we don’t know what the breakdown of the missing 2 million workers will be.

Hennessey’s hypothetical is a representative example of the kind of tradeoff someone might confront. Because of the way the ACA was designed, it could be much worse.

John McCormack illustrates at The Weekly Standard how a 55-year-old Wisconsin couple could pay $13,000 a year more in insurance once they earn just above 400 percent of the poverty line. On income they earn above 400 percent of the poverty level, the effective tax rate will be over 100 percent until they earn about $13,000 more. If they were both 64, the next $20,000 would effectively be taxed at 100 percent. For a real-life example, see this story in the New York Times, featuring a New Hampshire family that could see their premiums cut in half if they earned just a few thousand dollars less per month. (The hypothetical Wisconsinites, it should be noted, face a much steeper cliff than most people in the country — insurance in their area is, for a variety of reasons, extremely expensive. The $13,000 and $20,000 numbers above are about $5,000 and $9,000 for the typical American of those ages.)