February 5, 2014

CBO: The ACA is Driving Workers Out of the Workforce

Charles Blahous

J. Fish and Lillian F. Smith Chair
Summary

For the past few years, a problematic phenomenon has troubled economists: US job growth has been anemic even as the unemployment rate has steadily dropped, mainly because large numbers of workers are dropping out of the workforce altogether.  The unemployment rate doesn’t fully capture the weakness of our labor market because the rate is calculated only as a percentage of those actively looking for work.  Unfortunately, the percentage of Americans who are even attempting to work has dropped to its lowest level in more than thirty years.  

For the past few years, a problematic phenomenon has troubled economists: US job growth has been anemic even as the unemployment rate has steadily dropped, mainly because large numbers of workers are dropping out of the workforce altogether. The unemployment rate doesn’t fully capture the weakness of our labor market because the rate is calculated only as a percentage of those actively looking for work. Unfortunately, the percentage of Americans who are even attempting to work has dropped to its lowest level in more than thirty years.  

A recent Washington Post column discussed some of the factors contributing to this costly exodus from the workforce.  One factor – the Baby Boomers entering their retirement years – is something other analysts and I have long warned about.  Some have attempted to wish away our fiscal problems by positing rosy economic growth scenarios that ignore population aging; but as many of us have pointed out, economic growth depends significantly on workforce growth, and population agingundercuts that. Other factors that may be contributing to workforce shrinkage include the recent increase in Social Security disability benefit awards, as well as the general discouragement of workers amid a historically weak economic recovery.

But now a new Congressional Budget Office report  identifies another culprit driving workers out of the workforce:  the Affordable Care Act (ACA, often referred to as “Obamacare.”) CBO finds that the ACA is deterring Americans from holding jobs – and will do so much more in the future.  An already frequently-cited statistic from the CBO report is that the ACA will by itself reduce the effective number of workers by2.0 million by 2017, and by 2.5 million by 2024.  

Driving millions of additional workers out of the workforce in the current economic environment is a disastrous effect that renders nearly all of our economic policy challenges even more difficult to solve. Despite this, some ACA supporters have actually tried to spin the CBO report as good news.  It isn’t; it’s a huge problem.  The productivity of workers sustains the economy; it’s what generates the income that supports Americans’ quality of life.  Even before the ACA was passed, we were looking at sobering projections of the slowest net workforce growth in decades as the baby boomers entered retirement.  Pushing more Americans out of the workforce slows economic growth, lowers government revenues, worsens deficits, and results in greater burdens on the workers that remain.

CBO’s report explains in detail how the ACA is contributing to our small-workforce problem.  CBO notes three key phenomena resulting from the ACA: 1) high marginal tax rates on work by low-income Americans; 2) penalties on employers, which reduce their demand for workers, and 3) higher direct taxes to finance ACA spending.  All of these reduce the numbers of Americans with jobs.

The first and most important effect is the ACA’s imposition of high marginal tax rates on work by low-income Americans.  The ACA causes this by providing the most generous subsidies to the lowest-income individuals, gradually diminishing those subsidies as incomes rise.  Americans who choose to work and earn more will lose a great deal of the subsidies they receive by working less.  

CBO provides some numerical examples:

In 2014, for example, a single person or a family whose income is 150 percent of the FPL (Federal Poverty Line) and is eligible for subsidies will pay 4 percent of their income for a certain “silver” health care plan purchased through an exchange; if their income is 200 percent of the FPL, they will pay 6.3 percent of their income for that plan. An increase in income thus raises the enrollee premium (and reduces the subsidy) both because the percentage-of-income formula applies to a larger dollar amount and because that percentage itself increases. People whose income exceeds 400 percent of the FPL are ineligible for premium subsidies, and for some people those subsidies will drop abruptly to zero when income crosses that threshold. Cost-sharing subsidies also phase out in steps with rising income, declining sharply at 150 percent, 200 percent, and 250 percent of the FPL.

CBO connects the dots to explain explicitly why this thins the ranks of workers:

For some people, the availability of exchange subsidies under the ACA will reduce incentives to work both through a substitution effect and through an income effect. The former arises because subsidies decline with rising income (and increase as income falls), thus making work less attractive. As a result, some people will choose not to work or will work less—thus substituting other activities for work. The income effect arises because subsidies increase available resources—similar to giving people greater income—thereby allowing some people to maintain the same standard of living while working less.

CBO’s findings should not surprise anyone.  Not only economists but laymen instinctively understand that if individuals can receive a substantial benefit while working less or without working at all, and if they lose a large portion of that benefit if they work more, many will quite rationally choose to work less.  CBO’s reporting of the obvious has become newsworthy largely because it has conflicted with repeated assertions by the White House and its political allies that the ACA will result inhigher employment.” 

CBO finds specifically that the design of the ACA’s health exchange subsidies reduces employment.  It similarly finds that “expanded Medicaid eligibility under the ACA will, on balance, reduce incentives to work.”

The second factor cited by CBO is the ACA’s penalties on employers, which reduce their demand for workers (and later, worker supply as well).   Again, CBO explains:

Beginning in 2015, employers of 50 or more full-time equivalent workers that do not offer health insurance. . . will generally pay a penalty. That penalty will initially reduce employers’ demand for labor and thereby tend to lower employment. Over time, CBO expects, the penalty will be borne primarily by workers in the form of reduced wages or other compensation, at which point the penalty will have little effect on labor demand but will reduce labor supply and will lower employment slightly through that channel. 

CBO notes that employers are often very reluctant to cut wages even when externally-imposed costs like those from the ACA reduce the funds available to compensate workers.  Consequently, the ACA’s assessment of employer penalties is likely to be manifested in fewer jobs instead.  And if the minimum wage is increased as some are advocating, the ability of employers to absorb these penalties without reducing jobs will become even more constrained.

Third and finally, the ACA’s new spending is financed in part by new taxes that further reduce job growth.  CBO lists the ACA’s Medicare payroll tax increase, its so-called “Cadillac plan tax” on high-cost health insurance plans, and its penalty tax assessed on individuals without health insurance, as among the taxes that will reduce employment.

Perhaps most concerningly, CBO warns that these problems are only going to get worse; that is, the ACA’s effects in reducing employment will become more severe.  One of the reasons is that “the number of people who will receive exchange subsidies—and who thus will face an implicit tax from the phase-out of those subsidies that discourages them from working—will be smaller initially than it will be in later years.”  

From any reasonable vantage point, the CBO findings are a disaster for the ACA’s advocates, as they substantiate in detail how and why the law will thin the ranks of taxpaying workers and increase the burdens they each must carry.  This has produced some bizarre efforts at counter-spin.  Some have tried to argue that it’s not really job-destruction if the employment reductions result from workers voluntarilyleaving the workforce.  The White House has even argued that CBO’s report substantiates that the ACA will cause fewer people to be “trapped in a job” by the need to maintain health insurance.  But when the ACA was first promoted it was as a means of avoiding “job lock” in the sense of enabling Americans to move to different jobs – not to drop out of the workforce altogether.

In the end, there is no avoiding that the ACA is exposing low-income workers to high marginal tax rates and reducing the numbers of Americans with jobs.  In our current economic environment, with millions of baby boomers heading into retirement and unsustainable deficits on the horizon, that is a huge self-inflicted problem.  Responsible leadership requires addressing the problem, not evading it.