Premium Subsidies Lay a Trap for Small Businesses

by Paul Winfree

One of the main criticisms of Obamacare is that it will significantly reduce the incentive for small businesses to hire — especially once the premium subsidies become available in 2014.

The premium subsidies are Obamacare’s way of making health insurance more affordable for low-income earners who buy coverage in the new exchanges. Eligibility for a subsidy is limited to people with incomes les than four times the poverty line who lack public or employment-based insurance. The values of the subsidies are set so as to limit the amount a person contributes towards insurance as a percent of income.

But the actual implementation will be complex, thanks to an odd retroactive feature.

Say you’re under 65 and not on Medicaid (or CHIP), and the year you would be eligible to purchase insurance through an exchange is 2014. Your premium subsidy is determined by your income and family structure from two years earlier (in this case 2012), applied against the poverty level for the calendar year in which you purchase the insurance (2014).

Though complicated to determine, the consequences of the retroactively applied subsidy information are far worse.

For instance, what if your income or family structure is different in 2014 than it was in 2012? Obamacare allows people to apply for “changes in circumstances” if they got married or had children in the interim. It also allows those who lose a job or expect to experience significant reductions in income (a decrease of 20 percent or more) to apply for an adjustment to their subsidy.

However, those who experience a significant increase in income will have to pay additional taxes equal to the amount of the overpayment in the premium subsidy for the tax year in which the credits are used to buy insurance. Originally, Obamacare capped the amount the IRS could collect at $400 a family. Congress increased that cap to pay for the most recent Medicare “doc fix,” giving the IRS authority to go after amounts as low as $600 for people making less than two times the poverty line, and as high as $3,500 in overpayment for people making under five times the poverty line.

Does anyone experience such large swings in income? Small business owners can experience a tremendous amount of year-to-year change in income. In fact, it’s easy to imagine a small business owner who qualifies for a tax credit to buy insurance in 2014 based on income in 2012 and experiences a profitable year in 2014 only to owe the value of the tax credit (on top of their other taxes) in April 2015, regardless of how well the business is doing by that time.

Unless they have a crystal ball, small-business owners who qualify for the tax credit must consider the possibility that their income may jump, which would force them to pay back a large portion of the overpayment. This threat of a potentially large tax bill could induce many of the more 4 million small-business owners who would likely qualify for premium subsidies to save money for the taxman rather than invest in their business or hire new employees.

Take a 50-year-old small business owner — married, with two children and a household income of about $80,000 in 2012. Based on data from the Kaiser Health Reform Subsidy Calculator, her household will qualify for a premium subsidy of more than $9,000 in 2014. However, if she makes $20,000 more in 2014 relative to 2012, she will have to pay back $3,000 on top of the taxes she will already pay. In other words, she’ll owe the government about 60 percent of the $20,000 (including payroll and state taxes) by having a more successful year in 2014 relative to 2012.

How will this influence her decision to hire new employees or invest in the business? Tax economists have studied how small-business owners respond to changes in personal income tax rates. Based on the findings of those studies, the likelihood of the business owner in this example hiring new workers is reduced by about a third.

As the economy struggles to recover, such a policy is more than just administratively burdensome. It could be economically catastrophic.

— Paul Winfree is a senior policy analyst in the Center for Data Analysis at the Heritage Foundation.