The Agenda

Andrew Biggs on Health Spending and Inequality

Earlier this week, Andrew Biggs wrote an illuminating reply to Thomas Geoghegan’s op-ed calling for a more generous Social Security system. The following is a brief sample:

 

Geoghegan mocks those who say we can’t afford higher benefits. “Oh, come on: We have a federal tax rate equal to nearly 15 percent of our G.D.P. — far below the take in most wealthy countries.” But tax revenues aren’t low because we cut taxes. They’re low because we’ve run the economy into the ground. When people’s incomes drop or they lose their jobs, tax revenues fall too. Once the economy recovers, tax revenues are slated to rise—to around 20 percent of GDP under President Obama’s budget, a level that is above the historical average and which does nothing to fully fund the Social Security program Geoghegan wants to expand by over 25 percent.

Geoghegan then states, “the labor economist Richard B. Freeman points out that the hourly earnings of workers dropped by 8 percent from 1973 to 2005 while productivity shot up 55 percent or more. The United States is one of the few developed countries where workers are routinely cheated of a share in higher productivity.” Actually, as Harvard’s Martin Feldstein has pointed out, this is an almost entirely bogus statistic. Productivity growth over time is calculated using a different measure of inflation (the GDP deflator) than income growth (the Consumer Price Index). Moreover, wage growth is less important than compensation growth, which accounts for the increasing role of benefits. Feldstein shows that “total employee compensation as a share of national income was 66 percent of national income in 1970 and 64 percent in 2006. This measure of the labor compensation share has been remarkably stable since the 1970s.”

Compensation is distributed unevenly across the workforce, and so are productivity levels.

I also greatly profited from Biggs’s thoughts on the role of rising health expenditures in exacerbating inequality in cash compensation:

Imagine two workers: high paid and low paid. High paid receives total compensation of $100,000, of which $5,000 goes to pay for health coverage. Assuming no other benefits, his salary would be $95,000. Low paid receives total compensation of $25,000, which minus $5,000 employer health coverage costs leaves him with $20,000 in salary. The ratio of high to low’s compensation would be 4-to-1 and of their salaries 4.75-to-1. Assume that both workers increase their productivity by 1 percent annually and their total compensation also rises at that rate. But now imagine that health costs rose at 4 percent annually and these rising costs were deducted from their salaries. While the ratio of high to low’s compensation would remain the same at 4-to-1, the ratio of high to low’s salaries would rise every year—to 4.87-to-1 after 5 years and 5.06-to-1 after 10 years.

Biggs cautions that we shouldn’t read too much into this:

This isn’t to say that rising health costs are the sole driver of income inequality. After all, wages have stagnated for many low earners who don’t receive employer health coverage, while pay for extremely high earners has risen faster than average compensation in the economy. Nevertheless, it appears that rising health costs could explain a good chunk of the wage stagnation we’ve seen toward the middle of the earnings distribution, among people who do receive health coverage but aren’t super-high earners.

Yet there may well be reason to fret:

 

If rising health costs guaranteed rising health value, then the measured increase in income inequality would literally be nothing to worry about. For instance, if instead of rising health contributions driving the effect it was rising employer pension contributions, it really wouldn’t be a big deal—less salary today, more benefits in retirement.

But the concern is that rising health outlays aren’t producing value at the margin. 

Biggs ends his post with a lament concerning the paucity of good individual-level data on compensation as opposed income, which can give us a misleading portrait of how firms and workers are faring.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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