Saturday, October 31, 2009

Disincentives from Health Reform

Here is my column in tomorrow's NY Times about the marginal tax rates implicit in the health reform bill making its ways through Congress. Let me add a few additional observations on the topic.

1. Here are the CBO numbers on which the article is based. Unfortunately, the Times did not run the table of implicit marginal tax rates that I gave them based on the CBO numbers. But the example I used in the piece (an implicit tax rate of 23 percent) is representative. For lower income levels, the implicit marginal tax rate is even higher. Between $42,000 and $54,000, the implicit marginal tax rate from health reform is 34 percent.

2. When CBO estimates the budgetary cost of such bills, it holds GDP constant. If you think (as I do) that large increases in marginal tax rates tend to depress labor effort and thus GDP, then you should be wary of claims based on CBO scores that the health reform bill is deficit neutral. Lower GDP will mean lower tax revenue and thus a larger budget deficit.

3. How much do people respond to tax rates? Economists differ in their answer to this question. The latest thinking on this topic, by my Harvard colleague Raj Chetty, indicates that the elasticity of taxable income with respect to (1-tax rate) is about one half. So, for example, if a person starts with a marginal tax rate t of 0.3 and health reform raises it to 0.5, the percentage change in 1-t, using the midpoint method, is .2/.6, or 33 percent. With an elasticity of one half, his taxable income will fall by 17 percent. Thus, the economic impacts from these implicit tax hikes are sizable.

4. In my Times piece, I wrote, "None of this necessarily means that health reform is not worth doing. President Obama’s push for reform is premised on the belief that access to good health care should be a right of all Americans — a proposition better judged by political philosophers than economists. But we should not forget the cost of translating that noble aspiration into practical policy."

This passage may seem a bit passive-aggressive, as I appear to be criticizing the bill without really taking a stand. My aim, however, is to emphasize that economics alone cannot settle the debate.

Behind the healthcare debate is the classic tradeoff between equality and efficiency. Consider the following question, which is not about healthcare per se: Would you favor a substantial increase in marginal tax rates for millions of middle and upper income Americans to provide more resources for those toward the bottom of the economic ladder?

Your answer to this question cannot be determined by positive economics without adding in some normative judgments. But your answer should strongly influence your view of the health reform bill. The bill moves us closer to much of Western Europe by favoring equality and paying the price of reduced efficiency from much higher marginal tax rates.

That may be a policy choice Americans want to make. But before buying the merchandise being offered by Congress, I hope we all take a close look at the price tag.