Competitiveness & Health Reform

This morning, the Wall Street Journal editorial page questioned the oft-alleged link between health care costs and the competitiveness of American business. Echoing Council of Economic Advisers Chair Christina Romer, it referred to that argument as “schlock.” At the same time, everyone interested in health policy is still absorbing the trillion-dollar price tag that the Congressional Budget Office (CBO) put on the Kennedy health bill.

I’d like to point out that these two issues – any link between health care and competitiveness and the estimated cost of health reform – are closely related. The way that CBO estimated the budget impacts of the Kennedy bill implies that health care has little effect on competitiveness. If you take the contrary view, that health care is a big deal for American competitiveness, then you should also believe that CBO has underestimated the difficulty of paying for health reform.

To explain why, let me start with CBO’s recent cost estimate (which I discussed in greater detail the other day). The headline story is that the Kennedy health bill would increase the deficit by slightly more than $1 trillion over the next ten years. Often overlooked is the fact that this trillion dollar figure is the net of two major changes: The bill would increase government health spending by about $1.3 trillion and increase tax revenues by $260 billion. The net impact is thus slightly more than $1 trillion.

Why do tax revenues increase?  Because under the bill, millions of workers would get health insurance from an exchange rather than from their employer. In other words, fewer workers would receive employer-sponsored health insurance. CBO assumes that employers would still compensate those workers at market rates, but more of that compensation would be in the form of wages and salaries.  That’s a big deal from a revenue perspective because wages and salaries are subject to income and payroll taxes, but employer-sponsored health insurance is not. Over ten years, the resulting revenue boost is substantial: almost $260 billion, which would cover about 20% of the increase in government spending.

What does this have to do with competitiveness? If you accept CBO’s estimation methodology, you are also accepting the idea that reforming health care won’t reduce compensation costs (this conclusion is subject to a few caveats that I discuss at the end of this post).  And once you’ve accepted that compensation costs are unchanged, you have to conclude that reforming health care doesn’t make American firms more competitive. It will change the way that employees get compensated, but it won’t give firms an edge in the global marketplace.

I think that CBO has this right (we made similar calculations when I was there) and that most economists would agree (see, for example, this piece by Greg Mankiw, which quotes from a detailed CBO analysis; you can then Google/Bing/Cuil to find responses to Greg).

If you have doubts, however, let me note that paying for health reform becomes much more difficult if you don’t adopt the CBO approach.  If wages and salaries are unchanged, for example, then the $260 billion of revenue from individual income taxes and payroll taxes disappears. There would presumably be an increase in some other taxes somewhere, with the amount depending on your specific assumptions (e.g., do the benefits of health reform show up as higher profits?  Lower prices for domestic consumers?  Lower prices for foreign consumers?).  Wages and salaries face such high tax rates however (income taxes plus payroll taxes), that I doubt you would come close to generating $260 billion from these other sources. In short, if you believe that health reform would improve competitiveness, you should also believe that health reform will be even harder to pay for than CBO’s estimates suggest.

Finally, here are those caveats I mentioned:

(1) Wages and salaries don’t adjust instantly. It’s therefore possible that employee compensation might fall temporarily – boosting competitiveness – while the adjustment takes place.  But that’s a short-run phenomenon.

(2) The analysis may be somewhat more complicated in industries where employees are heavily unionized. In those industries, the impact depends on collective bargaining rather than the workings of the broader labor market.  My sense, though, is that union representatives are sophisticated in trading off wages vs. health benefits, so the basic idea would remain valid.

(3) The analysis is also more complicated for jobs that pay near the minimum wage. There may be some firms that would be willing to hire more employees at the minimum wage, for example, but can’t afford to do so if they also have to pay for health insurance (and aren’t willing to hire them without health insurance). Those firms might expand their hiring – and become more competitive – after health reform. Of course, that’s really a story about the minimum wage, not health care more broadly.

(4) For some employers, health care costs are more of a legacy problem (i.e., the health care costs of retirees and their families) than they are an operating problem. Reducing those legacy costs could ease the financial strain on those firms. That would certainly help shareholders, but whether it would enhance their competitiveness is an open question.