Saturday, October 18, 2008

Taxing the Uninsured

Most economists agree on these two propositions about tax incidence (covered in Chapter 6 of my favorite textbook):
  1. It does not matter which side of a market you tax. A tax on buyers is the same as a tax on sellers. In particular, a tax on employers is equivalent to a tax on employees.
  2. Because labor demand tends to be more elastic than labor supply, a payroll tax falls largely on employees.

Now consider the Obama health plan. A major element of the plan is an extra payroll tax on firms that do not give their workers health insurance. By the basic theory of tax incidence, this is equivalent to a tax on workers without insurance.

In other words, the Obama plan is much the same as imposing a health insurance mandate, backed up by the penalty of a tax surcharge on your earnings if you fail to have coverage.

One difference: If an individual buys his own health policy, rather than getting it through his employer, he still pays the tax. That is, the Obama policy continues, even reinforces, a strong policy-induced preference for employer-provided over individually-purchased health insurance.

Update: Some readers interpreted the above description as a criticism. Not so! Note that the above post is entirely positive, not normative. I was merely explaining what the Obama plan does.

Is there a good rationale for taxing the uninsured? Perhaps. If an uninsured person can get free health care at an emergency room, passing the cost to others, then lack of insurance entails a negative externality. One can therefore make a Pigovian case for taxing the uninsured.

This Pigovian argument, however, would not point toward an earnings-based corrective tax, as Obama proposes. A high-earnings uninsured person does not impose more externalities than a low-earnings uninsured person. Indeed, if the former is more likely to pay his own medical bills, just the opposite is the case.

Moreover, I don't see a good argument for favoring health insurance bought through an employer over health insurance bought as an individual. A level playing field makes more sense. David Cutler notes in his book Your Money or Your Life,

Health insurance is not something that is made better by tying it to employment. As a result, essentially all economists believe that universal coverage should be done outside of employment.

I agree with David. Note that the Furman-McCain plan moves toward a level playing field.

Update 2: Jeff Jacoby weighs in.