NCPA - National Center for Policy Analysis

Government Subsidies Will Reduce Economic Activity

May 2, 2011

Little attention has been focused on health reform's most problematic provision: government subsidies to help individuals and families purchase health insurance.  The health law establishes insurance exchanges and minimum standards for the insurance policies that can be offered.  Because the policies will be so costly, there is a subsidy for buyers that phases out as family income rises.  This sounds reasonable -- but the subsidies required to make a "qualifying" insurance policy affordable are so large that their phase-out creates chaos, says Daniel P. Kessler, professor of business and law at Stanford University and a senior fellow at the Hoover Institution.

  • Starting in 2014, subsidies will be available to families with incomes between 134 percent and 400 percent of the federal poverty line.
  • For example, a family of four headed by a 55-year-old earning $31,389 (134 percent of poverty) in 2014 dollars in a high-cost area will get a subsidy of $22,740.
  • This will cover 96 percent of an insurance policy that the Kaiser Family Foundation predicts will cost $23,700.
  • A similar family earning $93,699 (400 percent of poverty) gets a subsidy of $14,799.
  • But a family earning $1 more -- $93,700 -- gets no subsidy.

Economists call large, discontinuous changes in program benefits like this "notches."  Although notches might be administratively convenient, they have terrible incentive effects.

  • To phase out the subsidy smoothly for families with incomes of 134 percent to 400 percent of poverty, the law would have to take away $22,700 in subsidies as a family's income rose to $93,700 from $31,389.
  • In other words, for every dollar earned in this income range, a family's subsidy would have to decline by 36 cents.
  • On top of 25 percent federal income taxes, 5 percent state income taxes and 15 percent Social Security taxes, this implies a reward to work of less than 20 cents on the dollar -- in economists' language, an implicit marginal tax rate of over 80 percent.

Source: Daniel P. Kessler, "How Health Reform Punishes Work," Hoover Institution, April 25, 2011.

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