Tax subsidies for employer-sponsored health insurance: updated microsimulation estimates and sensitivity to alternative incidence assumptions.

For many readers the term “microsimulation” may connote the use of data on persons (or establishments) to evaluate the possible consequences of a new or proposed policy. Such a definition, however, captures only some of the ways simulation is used within health services research. Consider studies that call for measures of after-tax income, eligibility for public insurance, or adherence to treatment regimes. In each case, micro data are enhanced using information from outside the dataset (tax rules, eligibility rules, or treatment guidelines), creating measures of value for researchers and policy makers. Simulated measures such as these can serve as building blocks for policy evaluations, but they may also play important roles in descriptive or behavioral analyses. In this article, we simulate the tax subsidy to private employer-sponsored insurance (ESI). ESI is the predominant form of health insurance in the nonelderly US population, covering 67.7 percent of adults and 58.3 percent of children for at least part of the year in 2009 (authors' calculations using the 2009 MEPS-HC). Current tax law provides strong subsidies to ESI by exempting employer premium contributions and most employee contributions from income and payroll taxes. The resulting “tax expenditure” is more than twice the tax expenditure for home mortgage interest and approximately half the size of Medicare or Medicaid.1 ESI tax subsidies are an ongoing source of policy debate. On the one hand, some have argued that ESI subsidies serve as the “glue” holding ESI risk pools together, mitigating predictable losses as low-risk workers cross-subsidize those with higher expected spending (Monheit, Nichols, and Selden 1996; Selden 1999; Selden and Bernard 2004). On the other hand, ESI subsidies tend to be poorly targeted, conferring the largest benefits on higher income families who are the least likely to be uninsured or covered by public insurance (Gruber 2002; Chernew, Cutler, and Keenan 2005). ESI subsidies may also encourage higher than optimal levels of coverage and medical care consumption (Feldstein 1973; Pauly 1986; Newhouse 1992). The Patient Protection and Affordable Care Act (PPACA) modifies ESI tax subsidies in several respects, increasing subsidies for small employers and reducing subsidies for high-premium plans (Kaiser Family Foundation 2011a). Nevertheless, concerns over equity and efficiency, in conjunction with concerns over federal debt, have motivated proposals for additional changes in this largest of individual tax preferences (Antos, Wilensky, and Kuttner 2008; Buchmueller et al. 2008; Furman 2008; Pauly 2008). Despite the policy importance of the ESI tax subsidy, the implicit nature of this “expenditure” means that it cannot be directly measured. Rather, it must be simulated. In principle, this appears to involve straightforward calculations based on marginal tax rates and premium contributions. However, worker marginal tax rates and employer/employee contributions are generally not found on a common dataset, so researchers must combine information from multiple sources (Gillette et al. 2010; Gruber 2011). Indeed, prior to 2012 even Internal Revenue Service (IRS) tax records have not contained the premium contribution data required to calculate ESI tax expenditures.2 Our approach uses data on workers from the Medical Expenditure Panel Survey Household Component (MEPS-HC) to create synthetic workforces for each establishment in the MEPS Insurance Component (IC), refining the method developed in Selden and Gray (2006). Another computational challenge is that tax subsidy calculations require assumptions regarding the incidence of employer contributions. Economists generally agree that workers bear the burden of employer ESI premium contributions through lower cash wages. There is far less agreement, however, on exactly how employers adjust cash wages when workers have heterogeneous health risks and make heterogeneous decisions regarding take-up and plan choice. Tax subsidy estimates typically rely on the “Statutory” assumption that each enrolled worker bears the cost of the employer's premium contribution to the plan in which he/she enrolled. The (implicit) assumption is that employers set cash wages after observing take-up and plan choice and that cash wage offsets do not reflect the health risks of workers (or their covered dependents). Relatively little is known, however, about the sensitivity of tax subsidy estimates to assumptions regarding the incidence of employer contributions. Selden and Bernard (2004) used simulation to explore the implications of alternative incidence assumptions for studies examining progressivity across households and worker incentives for risk pooling. We build on their approach, using simulation to explore the implications of assumptions regarding employer targeting of cash wage offsets for estimates of the aggregate ESI subsidy and its incidence across establishments. The next two sections describe the MEPS-IC and HC databases that we use and our simulation methods. The last two sections present our results and conclusions.