The Corner

ACA, IRS, and Perverse Incentives

The Obama administration is using the IRS to demand that employers certify, under penalty of perjury, that they are not reducing their work forces in order to sneak under the enforcement floors of the Affordable Care Act mandates. About the mind-numbing legal contortions that the administration has had to put itself and the country through in order to  at least appear to justify that, I have nothing to add to the excellent observations of Andy (“My Second-Favorite”) McCarthy.

The knuckle-draggingly primitive economics of the thing is worth thinking about for a moment, though. The Affordable Care Act creates powerful economic incentives for firms not to grow above a certain size or to reduce their employee headcounts if they are on the cusp of one of those bright lines. The administration’s remedy to the perverse economic consequences it has created is to pass a regulation: “There shall be no perverse economic consequences!” Ingenious — if your understanding of the economy is that of a four-year-old.

Here in grown-up world, the perverse incentives of regulation do not disappear simply because a regulator sends out a letter saying that they shall not exist, IRS or no IRS. Employers have almost exactly the same perverse incentives they have now that they had before the no-perverse-incentives regulation, the only new wrinkle being that if they want to act on those incentives, they either have to cross the IRS or think up a “legitimate” business reason for reducing their staffs. Of course, not putting your head on the regulatory chopping block is in reality a legitimate business reason, but that won’t do. Even so, it will not be terribly difficult for many businesses to think up “legitimate” reasons to have one or two fewer employees. Thus the Obama administration is dishonest in itself and a source of dishonesty in others. The administration has not eliminated incentives to lay off employees; it has simply created incentives to lie, or, to put it more charitably, to engage in regulatory evasion.

But the no-perverse-incentives rule, like most of what the Obama administration does, looks only one direction in time. The real weight of perverse incentives will fall upon growing firms, those that will be larger in the future. If the next employee puts you in the federal crosshairs, then you are going to have a pretty high bar to clear for hiring that employee. Sometimes it will be inevitable, and sometimes the costs may seem to be worth it. Sometimes, Jeff down in the warehouse is going to get the shoe in order to make room for a new guy in finance. You will have stronger incentives to outsource non-core business processes and to replace workers with capital whenever possible. 

But whatever happens, the perverse incentives still will be there, and even the mighty, mighty IRS cannot will them away. The administration is embarrassingly naïve to think otherwise.  

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