The Patient Protection and Affordable Care Act (ACA; P.L. 111-148 and P.L. 111-152 ) contains several provisions to encourage employer-sponsored health coverage, particularly among small businesses. The provisions that most directly relate to small businesses are (1) an employer penalty for not providing health insurance, (2) a tax credit to increase the affordability of health care for the smallest firms, and (3) small business health insurance exchanges designed to increase plan options and lower plan costs. The implementation of the ACA's provisions to encourage employer-sponsored health coverage, particularly those provisions that relate to small businesses, has been the subject of increasing attention. The ACA's employer penalty aims to encourage employers to retain or offer health coverage to their employees. Some maintain that the direct costs of the employer penalty and related compliance costs will be damaging to small businesses. Core issues regarding the employer penalty as related to small businesses include hiring and workforce decisions, as well as their administrative costs. Although the employer penalty may not affect the decisions of employers with fewer than 50 employees because they are not subject to the penalty, the penalty could be part of decision-making calculations for employers that are on the margins of the penalty threshold and considering expanding their business. Several events have altered the ACA's implementation since its enactment in 2010: The Supreme Court ruled in 2012 that the ACA's requirement that states extend their Medicaid benefits to all adults under the age of 65 with incomes up to 133% of the federal poverty level was unconstitutional. It is now up to the states to choose whether to expand their respective Medicaid programs and increase health care coverage and affordability among some low-income workers. On June 4, 2013, the Department of Health and Human Services (HHS) announced that it is delaying enforcement of the ACA's requirement that the Small Business Health Options Program (SHOP) exchanges offer more than one plan from 2014 to 2015. The SHOP exchanges still opened in 2014, but they were not required to offer more than one plan to employers. On July 2, 2013, the Obama Administration announced a delay in the implementation of the employer penalty for all applicable firms until 2015, citing the need to simplify administrative complexities for businesses and give businesses more time to comply with an appropriate plan. According to the ACA, the employer penalty and the small business health exchanges were supposed to go into effect beginning in 2014. On February 10, 2014, the Department of the Treasury issued a final regulation that would delay implementation of the employer penalty for firms with fewer than 100 full-time equivalent (FTE) employees (i.e., firms with 50 FTE employees to 99 FTE employees) from 2015 to 2016. This report analyzes several ACA provisions that are most relevant to small business. Because there is no single, precise definition of a small business in the ACA, this report discusses issues that are relevant to businesses that are sometimes considered to be small in more general terms (e.g., fewer than 500 employees). First, it provides an overview of the rationale behind employer-sponsored health insurance. This rationale informs the purpose and design of many of the ACA's small-business relevant provisions. Second, it describes the ACA provisions that are most relevant to small business, including the employer penalty, small business health care tax credits, and SHOP exchanges. Third, it analyzes each provision for potential economic effects on small businesses. Lastly, this report presents several approaches that could address some criticisms of the ACA's employer penalty and reduce its effects on small businesses. From an economic perspective, health insurance and health care markets have fundamental flaws that often lead to an inefficient allocation of resources. This inefficient allocation of resources, also known as a market failure , leads to a mismatch between demand and supply for a product because prices fail to accurately reflect the product's costs and benefits. From an economic perspective, the presence of a market failure may provide a justification for government intervention to resolve inefficiencies, unless the cost of correcting the failure is greater than the expected efficiency loss. Access to health insurance generates externalities , or spillover effects to society, that might be difficult for any individual participant in the health insurance market to take into account. For example, more insured individuals decrease the risk that others might contract certain contagious diseases. Also, ill individuals without coverage might use publicly funded resources, especially if their illness becomes serious enough that it depletes their wealth (a negative externality). The net cost of these externalities to society may not be fully reflected, or internalized , by firms and workers in the cost of health insurance. Therefore, the supply and demand for health insurance in the private market may lead to an undesirable level of insurance from the perspective of society as a whole. In the private market for health care, individuals typically know more about their health status than insurance firms and those who generally desire more health care tend to seek out health insurance. This market failure is called adverse selection . Adverse selection makes it difficult for insurance firms to predict costs and establish prices based on predicted costs. Also, individuals who desire the most health care coverage tend to be the least healthy, whereas healthier people tend to desire less heath care coverage. Because some healthy people opt not to have health care coverage, the average price of insurance increases because those now in the insurance pool are less healthy. Rising costs push more people out of the market for health insurance because they believe the costs of insurance exceed the benefits. The end result is that many individuals, some by choice and some due to cost, will not have health insurance. In addition, even if both parties are informed about health status, people who have preexisting conditions or other characteristics that make use of health care more likely (such as old age) may not have, or be able to afford, health insurance. Individuals could be limited in their capacity to pay for health insurance due to low incomes. In this instance, a lack of individual health care coverage can still impose the same negative spillover effects on society. Aside from the issues of adverse selection and spillover effects from uninsured individuals, society as a whole can view health insurance not as individual insurance but as social insurance. From a social insurance perspective, having more insured individuals spreads the risk (and costs) of becoming ill across more individuals, including, for example, those born with compromised health, those who developed health issues during childhood, or those who lose employer health insurance due to a job loss or change in employment. Various types of risk-pooling mechanisms have reduced the negative externalities associated with the private health care market. Medicare has addressed the problem of adverse selection and excessive among the elderly, and employer-sponsored health insurance (ESI) has significantly reduced this problem among the working population. Some states also limit variations in premium costs. In addition, ESI provides a pooling mechanism that is unrelated to health factors and thus addresses both the adverse selection issue and the problem of being priced out of the market for those with ill health. ESI also tends to reduce administrative costs compared with such costs when individuals purchase coverage on their own. These pooling and administrative advantages are lessened for businesses with few employees. According to economic theory, the price of employer-sponsored health care benefits should offset wages so that employees as a group are still incurring the cost of insurance but do not face the difficulties they would with nongroup private insurance purchase. Employers with small pools of individuals may experience some of the same types of problems as individuals. If there is one employee who has (or whose family has) a serious health problem, the cost for insuring the group could be relatively high. Further, administrative costs per employee are larger for small firms; one study estimates these costs are 18% higher for small businesses. Perhaps as a result, large firms are more likely than small firms to offer health care plans and to have higher employee-participation rates. Two crucial elements are cited as necessary to address the problems relating to adverse selection and lack of affordability, especially for those with preexisting conditions: some form of community pooling so that individuals with health problems (including age) would not have to pay a substantially different price and a provision to require most individuals to have health insurance. Because 55% of workers (as of 2011) are already covered by insurance provided by an employer (even if not their own, such as their spouse's employer), some could deem policies to further encourage ESI to be desirable. The benefits of ESI could induce more low-risk workers to purchase health insurance, thereby lowering overall risk pools and subsidizing the higher price of insuring workers with comparatively higher risk profiles. This section briefly describes the provisions in the ACA that are especially relevant to small businesses. A small business is defined in multiple ways throughout the ACA and differs from other conventional definitions of a small business. Thus, the scope of the firms affected by each provision varies. The ACA sets out a two-part calculation for determining which employers are subject to a monthly imposed penalty for not providing health insurance that meets minimum standards of "affordability" and "adequacy" set forth in the ACA. As previously mentioned, implementation of the employer penalty was originally scheduled to begin in January 2014, but the Obama Administration has delayed the penalty until January 2015 (2016 for firms with 50 FTE employees to 100 FTE employees). First, a business must employ enough workers to qualify as a large employer to be subject to the employer penalty. Small businesses with fewer than 50 FTs are not subject to the penalty. Total FTE employees are calculated by adding the total number of full-time workers (who average 30 hours per week or more) plus the number of part-time employees aggregated to FTE employees. Seasonal workers are generally not included in determining employer size. Second, the penalty will be levied only on large employers that have at least one full-time worker who receives a health insurance premium credit in the individual insurance exchange markets that began offering coverage in January 2014.