NCPA - National Center for Policy Analysis


May 18, 2010

The landmark health reform law signed by President Obama (ObamaCare) will require small businesses to provide health insurance to their employees.  This burden will be offset by a tax credit for each employee covered.  However, the credit is arbitrarily reduced as firms grow, penalizing employers that hire more workers or increase their salaries.  Thus, the credit may discourage firms from hiring more workers or higher-paid workers, say Devon Herrick, a senior fellow, and Pamela Villarreal, a senior policy analyst, at the National Center for Policy Analysis. 

How does the tax credit for small firms work?  From 2010 to 2014, businesses in some industries that employ 25 workers or fewer will qualify for a tax credit worth up to 35 percent of the employer's contribution to workers' health coverage.  Beginning in 2014:

  • Employers will be eligible for a 50 percent health insurance tax credit for their contributions to employees' coverage for two years, but they must pay at least half the cost.
  • Employers must obtain insurance through newly formed health insurance exchanges in order to qualify.
  • Employers must have no more than 10 workers, earning an average of $25,000 or less, to obtain the full tax credit. 

The credit is not available to sole proprietorships and their families. 

As a firm's average pay rises above $25,000, the tax credit is slowly withdrawn at a rate of 4 percentage points for every additional $1,000 in average pay, and it is completely withdrawn once average pay reaches $50,000.  Independently of workers' pay, the tax credit is also incrementally withdrawn for each increase in the size of the firm beyond 10 workers, and is completely withdrawn once the firm reaches 25 workers. 

The employer mandate for low wage workers will cause some employers to substitute capital for labor and more highly skilled workers for less skilled ones.  Thus, instead of hiring ditch diggers and giving each one a shovel, an employer might buy a backhoe and hire a more highly skilled operator.  An unintended consequence of ObamaCare is that some low wage workers will be unemployed who otherwise would not be, say Herrick and Villarreal. 

Source: Devon Herrick and Pamela Villarreal, "Obama's Tax on Job Creation," National Center for Policy Analysis, No. 703, May 18, 2010. 

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