Third Way has a new report questioning the ability of the health reform bills on the table to control costs. In writing about the report, Third Way's Dave Kendall argues that, while the bills cover the uninsured and provide more stable coverage to the middle class, "there's little debate that the first two of these promises will be kept, progressives still face skepticism over cost control.

"Third Way's NEW REPORT looks at the cost-control measures in the bills now before Congress and finds that the measures in these bills will, in fact, "bend the curve." We find that over the next 15 years:

• American businesses will collectively spend $684 billion less on health insurance premiums than they would have otherwise.
• Workers will spend $190 billion less on premiums.
• The rate of growth in Medicare spending will slow by more than one percentage point.

"We also identify and explain 12 specific measures of cost containment, such as spending less money to fix treatment mistakes (warranties and error reporting), steering people from emergency rooms to routine care (individual mandate and primary care access) and taking the guesswork out of treatment decisions (comparative effectiveness research).

"For the full report, CLICK HERE. Talking points are available HERE."

The employer mandate is a requirement that workers take a greater share of their compensation in the form of health benefits and less in wages. This is supported by economic theory and research, and is assumed by CBO in their estimates for the recent health reform bills. It is also well understood by unions, who have long attributed slowed wage growth to the rapid increase in health care costs.

For example, say we have a firm with one employer that is paid $15,000 per year, and that the employer can sell what this individual makes for $15,000, plus a little profit. This relationship is sustainable because the employer can cover his/her labor costs with revenues form the goods or services sold. Now, lets assume that a mandate is adopted that adds $2,500 in insurance costs for the worker, bringing total compensation to $17,500. If the employer can increase what they charge to $17,500, a sustainable equilibrium can be restored without reducing wages. However, this assumes no reduction in the volume of goods and services sold in response to the price increase.

Most of the uninsured are in small firms that have little control over what they can charge in their markets without reducing the volume of goods and services sold. So it is likely that the employer would restore balance by slowing the rate of growth in wages or otherwise cutting employee benefits if possible.

Of course, wages can not be reduced below the minimum wage. In these cases, the employer is likely to reduce their workforce through attrition or layoffs. For example, economic studies of the minimum wage have documented that increases in the minimum wage result in a small reduction in employment, although only a fraction of all minimum wage workers. Based upon this research, we published an estimated a loss of between 300,000 and 800,000 low-wage jobs under a “pay-or-play” mandate based upon the July Tri-Committee bill.

These losses of wages and a small number of jobs are inevitable under any government policy requiring employers to provide additional benefits to workers (including employer tax payments). However, this is true of other government policies such as the employer contributions to Social Security and unemployment insurance, which are popular programs. Once implemented, the employer coverage mandate could be as popular as these other mandatory programs. I guess we shall soon see.

How quickly declines (or increases) in fringe benefits will be translated into corresponding increases (or decreases) in cash wages will depend on a number of factors including the competitiveness of the industry, the tightness of the labor market in general and for the particular skill set, institutional constraints like minimum wage laws and labor contracts, and so forth. To assume otherwise is to believe employers consider cash wages as the only labpr rated cost of doing business--a strategy that is likely to produce a limited term employer--and that employees think jobs with and without fringes paying the same cash wage are equally attractive. If that were true why would employers ever offer fringe benefits?
How quickly the changes find their way into wage changes is an interesting empirical question.

In the economic theory that inspires economists on the issue of employer-paid fringe benefits, they initially model a market that has fully adjusted to all known economic facts. Such a market is said to be “in equilibrium.” Economists then explore at what new, fully adjusted equilibrium that market would settle down if it were “shocked” (as the jargon goes) with some change in policy – e.g., a change in taxes. This analytic approach is called “comparative statics,” because it merely compares two equilibrium positions of a market.

Using that approach, there is a trade-off between fringe benefits and take-home pay in any well functioning labor market, even though it may not be 100% dollar for dollar. (It may be somewhat less or even more than a 100% trade-off).

Usually economists do not model the dynamic path that the market follows from month-to-month or year-to-year to reach that ultimate new equilibrium, although it can be done with differential-equation models. If economists did model changes in fringe benefits dynamically, they probably would identify many situations in which, in the short run, employers might temporarily absorb into profit (or, for non-profit groups, into endowment) sudden increases in the cost of fringe benefits, such as sharp increases in health-care costs or, in this case, in taxes on fringe benefits. Similarly, if the premiums they pay for their employee’s health insurance were to go down, employers might temporarily take the savings into profits although, in a competitive labor market, they might then lose out to employers who actually added the savings to take-home pay.

So, in a very short-run, dynamic model of the labor market, Jason Rosenbaum may be right. Over the longer run, John Goodman is apt to be right – shocking and heretical as it may be for him to agree with a salt-water economist.

To quote none other than the late Douglas Fraser, distinguished former leader of the United Automobile Workers, on this point: “Before you start weeping for the auto companies and all they pay for medical insurance, let me tell you how the system works. All company bargainers worth their salt keep their eye on the total labor unit cost, and when they pay an admittedly horrendous amount for health care, that’s money that can’t be spent for higher [cash] wages or higher pensions or other fringe benefits. So we directly, the union and its members, feel the costs of the health care system. (in “A National Health Policy Debate,” (in Dartmouth Medical School Alumni Magazine (Summer 1989): 30.)

Now, as we contemplate the currently proposed tax in high-cost health insurance policies, let us recall whence that idea originated.

For decades economists and the policy makers whom they inspired have railed against the tax preference accorded employment-based health insurance.

That tax preference makes health insurance premiums paid by an employer a tax-deductible business expense. Although they clearly are part of an employee’s compensation, however, employer-paid premiums are not counted in taxable compensation under the tax code. Economists consider this a regressive tax preference, because it saves high-income earners with high marginal-tax rates many more dollars in taxes paid than it saves low-income earners in low marginal tax brackets. (Some people express the tax savings from the tax preference as a percentage of the employee’s earnings. Concluding that, percentage wise, the small dollar tax savings reaped by low-income workers may be a higher percentage of their low earnings than are the much higher dollar tax savings of the much higher incomes of high-wage earners, these analysts then conclude that the tax preferences is, in fact, progressive. I would not define progressivity that way. To me and most economists, it is the dollars than count.)

The total amount of taxes not collected on this tax preference has been estimated to be somewhere between $250 billion to $300 billion a year. Other taxpayers will have to make up that lost tax revenue with added taxes on other things, unless it is proposed to deficit-finance the tax loss in perpetuity.

Now, $250 to $300 billion a year would be more than enough to pay for fully universal health insurance coverage and then some. So the idea would be to harvest at least some of that lost tax revenue to pay for the current health reform bill.

It could have been done, for example, by adding the average employer-paid premium per employee in a firm to the employees’ W-2 form, but perhaps in an income-related way that would exempt low-income workers from the tax and expose to the full tax only employees earning, say, $150,000 or $200,000 or more, on the thought that such higher income people do not need public subsidies toward their health insurance premiums.

The Senate has chosen not to follow that straightforward route, but instead to impose a tax on health-insurance policies with high premiums. I rate it a rather unfortunate substitute for the straightforward approach; but in spirit, at least, it tries to get at the same thing.

It is a poor substitute for the scheme I propose here because, as everyone knows, the health insurance premium of an American family can vary for reasons other than the generosity of the medical-benefit package. It will be high in high-cost regions such as New York City, New Jersey or Massachusetts, and it can be high for small employers whose experience-rated premiums may reflect one or a few very sick people.

Were it not for the American penchant always to choose mind-boggling complexity over simplicity in health policy, I would hope that the Conference Committee might settle on the more streamlined approach I propose here. The Wall Street Journal’s editorialists, of course, will scream, as it their wont, that this approach would implicitly raise marginal tax rates – but let them scream. There is no free lunch in health policy.

Over years of talking with union leaders and employee benefits managers about the tradeoffs between health insurance contributions and wages, it is clear that both sides perceive that there is a tradeoff between these two types of compensation. So in a future labor negotiation under a Cadillac tax, cutbacks in premiums to stay under the threshold for the tax will go into higher wages (or pensions or other tax-favored benefits). Outside of collective bargaining, I have no doubt that in the long run, lower spending on health benefits will go to other compensation. But that does not mean that there will not be situations where the unpredictable nature of premium increases means that the combination of health benefits and other compensation is temporarily above market and the spur of the Cadillac tax will be enough to lead to lower health benefit contributions not being immediately offset with higher compensation of other types. But like John Goodman, I am convinced that over time, these forms of compensation are completely fungible.

One of the issues with the Cadillac tax is that it would apply to more than just Cadillac plans. The tax applies to any plan with premiums over $8,500 for single coverage and $23,000 for families regardless of the actual level of coverage (with adjustments for older beneficiaries and people in high-risk occupations). Therefore the tax applies equally to people with very comprehensive plans and people with less comprehensive coverage facing higher premiums due to age, utilization patterns and other factors.

The reach of the tax will grow over time. In a recent study, we estimated that if implemented in 2014, it would affect about 30.9 million people. This would grow to 49.8 million people in 2019 and 90.6 million people by 2029. This is because the thresholds are indexed to the CPI plus one percent while health care costs would continue to grow at a bout twice that rate. Thus more and more people are in plans that would pay more and more of the tax over time.

Thus, what begins as a “Cadillac” tax in 2014 becomes a “Buick” tax by 2019 and a “Chevrolet” tax by 2029.

There are positives to the tax. For example it creates an incentive for employers to adopt more efficient health plans so they can avoid paying the tax. It also provides an ever increasing stream of revenues (it grows by 11 percent per year) to the federal government. For example, under the Senate bill, funding would actually grow a little faster than program costs due to this feature of the tax, resulting in continued reductions in the deficit through 2029.

Excise taxes are a “regressive” way of paying for reform. The cost of the Cadillac plan tax and other excise taxes included in the Senate bill ultimately would be passed back to consumers in the form of higher insurance premiums regardless of income (the Senate bill also imposes excise taxes on branded prescription drugs and medical devices). Thus, the amount of the tax as a percentage of income actually increases as income falls (which is the definition of a regressive tax). This differs from the House bill, which imposes a5.4 percent surtax on incomes over $1.0 million.

True, the tax is not readily visible to consumers because it looks like it is paid by insurers. However, insurers are sure to pass the costs on to consumers so that it will be reflected in higher premiums.

Because there's a new study that says employer health costs do not drive wage trends. And a survey of employers [pdf] showed that the the vast majority would not take any "savings" they see under the excise tax and put them back into wages.

The historical record seems to show that the connection between benefits and wages is more tenuous than most economists think, and survey research says this connection will be tenuous in the future. If you have data to back up your theory that benefits are indeed a substitute for wages, you should lay that proof on the table so people here can read and discuss.

There is one point on which Jonathan Gruber is right and Jason Rosenbaum is wrong.

Employee benefits are a substitute for wages. I believe every serious study that has ever been done has found that there is a dollar for dollar tradeoff. This is so well established it's hard to believe anyone would even question it.

Those that promote the so-called "Cadillac" excise tax on workers' health care plans sell the tax on two arguments: First, that the tax will cut health care spending, and second, that the tax will increase wages.

As MIT's Jonathan Gruber (who's on the payroll at HHS) put it in the Washington Post:

And when firms reduce their insurance generosity, they make it up in higher pay for their workers. We saw this in the late 1990s, when the rise of managed care temporarily lowered insurance costs, and wages rose in real terms for the first time in many years. But as soon as managed care was weakened and health costs rose again, we once again saw flat or declining real wages in the United States.

The theory goes that if you start taxing workers' health care plans for the first time in American history, employers will cut heath care (apparently that's a good thing) and put that money back into wages.

Lawrence Mishel and the Economic Policy Institute is out with an eye-opening new study demolishing the second of those two claims. The report states:

Proponents of this theory point for evidence to the latter half of the 1990s, a five-year period when wages were growing rapidly while growth in employer health care spending was relatively constrained. They contrast the period from 1995 to 2000 with the periods from 1989 to 1995 and 2000 to 2006, when wages stagnated while health care costs grew much more rapidly.

There is logic to their argument, but it is only skin-deep and deeper examination will show it to be simply not true. The logic can be seen looking at trends in health care premiums and wages—wage growth fared better in the late 1990s when health care premiums grew more slowly than in the early 1990s and wages performed poorly in the 2000s, a period when health premiums grew strongly again.

However, digging just a bit beneath the surface reveals the following:

1. Health care costs are not large enough to substantially move wages as these proponents claim;

2. Examination of actual wage and benefit trends confirms that changes in the trajectory of health care costs did not materially affect wage trends over the last 20 years; and

3. The wage behavior described—accelerating in the late 1990s and more slowly thereafter —actually best characterizes wage growth for low-wage workers who have minimal access to employer-based health care. Conversely, this pattern of wage-growth over time is least pronounced for higher paid workers with the most health coverage.

The idea that if we were forced employers to spend less on health care (by taxing health care plans) they would therefore spend more on wages is not borne out by the evidence.

So what arguments are proponents of this tax on the middle class - which will hit one in five health care plans offered at work by 2016 - left with? That the excise tax is a way to control health care spending. But the proponents of this argument make the classic mistake of confusing lowering health care spending with shifting health care costs.

What will happen when a 40% excise tax kicks on plans with higher premiums? Companies will lower the value of the plans (lowering the premiums under the threshold for the excise tax) and make up the difference by raising the amount employees have to pay out of pocket. Or, employers could simply cut benefits. In other words the health care that is now paid for by the insurance plan will, after the excise tax, be paid for by the worker. It is possible that cost shifting to the worker could lower costs in the short run if workers don't spend as much on care, such as not going to the doctor when they have symptoms or postponing that dental clearning. But what if the symptoms were actually the first sign of cancer? Or the lack of preventive dental care led to expensive dental surgery later on? Their delayed care will be more costly - not to mention the consequences for their health.

The excise tax idea is, therefore, directly at odds with the other main goal of health reform - to get people better care. Taxing health care benefits is designed to get employers to spend less on health care. That policy will directly shift costs to you, and that means higher deductibles, less choice of doctors, and worse health benefits.

Ironically, for those who champion the proposal, the idea is less about policy than about revenue. The excise tax pays for a large part of the Senate health reform bill. But this is again contradictory - if the tax works and does reduce health benefits by moving employers and employees to non-"Cadillac" plans, it will raise less money. The two goals are at odds.

While proponents like Ezra Klein say that the excise tax is a good way to control costs, and that any cost control is going to "cause some pain," there are many better ways to control costs and pay for reform that involve reigning in powerful corporations, not shifting costs and "causing pain" to people. Ideas in the House bill like the public option or negotiating the prices paid for drugs in Medicare would cut health care spending without taxing the benefits of the middle class, shifting costs to workers, and/or making their coverage worse.

As EPI proves, health care costs are not taken out of wages. A tax on health care plans may indeed "control costs," but it does it by making health care worse or shifting costs. Instead of getting better health care at lower cost, which is what you'd get if we had, say, a public health insurance option, you're more likely to get what iphelgix, an IT worker who's health care plan is classified as "Cadillac" and will be taxed, expects: Worse benefits for workers, or rising health care costs at work.

The basic promise of health care reform is to guarantee good, affordable coverage for all. Much of what is in health care reform legislation does that. But the excise tax does just the opposite: It makes good health care less affordable. It should not be part of the legislation that Congress will soon pass.

The idea that the massive new taxes raised in either House or Senate health care bills are in service of overall cost control is just one of the great many collective fictions proponents of doing something on health care have perpetuated. The House doesn’t even head fake in this direction. It offers pure wealth redistribution, raising its money through general taxation on high earners.

The Senate made great efforts to sever the link between Medicare taxes and the Medicare program, pulls billions from taxes on insurance, pharmaceutical and medical device companies, and hilariously tanning salons, a testament to how truly pathetic the horse trading became in the search for a fix.

Some basic points have been missing from the analysis.

· Corporations do not pay taxes, only people do. Insurance has long been treated as a cash cow for politicians who tax premiums and spend the money on unrelated projects. Insurance companies merely increase the price that the consumer pays. This will be the same for pharmaceutical and medical devices.

· Taxes raise the price of goods and services. Consider that when politicians need money, they raise taxes on tobacco, arguing that it will render cigarettes dearer and, therefore, reduce consumption. Yet in deluded pursuit of not even close to universal health care, we are to believe that taxing health care products and services will reduce costs. It most certainly will not. At best, people will pay more and get less.

· Costs are not the price that a payer, call it a corporation or the government, shells out for a good or service, but the total resources devoted to an endeavor. These bills will radically increase—not decrease—health care costs. These bills will shift more resources to health care, extracting the funds from American households in disguised taxation—consider the loss of Flexible Spending Accounts—and funneling it through Washington.

This last point brings us directly to the attack on the now disparaged “Cadillac” health plans. A few short months ago, these plans were not the problem to be attacked, but rather the gold-standard, employer-provided benefit package that politicians once wished for everyone. The thresholds are not designed to penalize specialized executive carve out packages, but rather standard corporate plans. They are not attacked in a way that will reduce costs, but will merely shift them to employees, rank and file workers, who, at best, will be left with less generous health coverage and more taxable income. This can’t be denied, and it is the reason that Democrats are scrambling to exempt their best source of funding—union workers--from this fate. Finally, the press reports it as health insurance which is being taxed, but the reality is that it is all health related benefits—dental care, eye care, and flexible spending, which itself has been cut in an effort to raise billions of dollars from ordinary Americans.

The end result will be an amazing push/pull of government-mandated benefit packages and out of pocket spending thresholds and punitive excise taxes on the funds necessary to purchase these packages. A cynic might note that the reason that the Democrats left a major role for the insurance companies to be the public utilities administering the program is so that they can continue to blame them for the inevitable results: higher taxes, less disposable income, higher health care spending and millions still uninsured.

Barack Obama is taking heat these days for endorsing the same idea he pounded on John McCain for endorsing during the election: taxing health insurance benefits.

True? Yes and no.

Yes, Obama is being a hypocrite. No, he’s not doing what John McCain proposed to do. Which is too bad.

The tax on health insurance in the Senate bill really is a tax on insurance. And since it’s not indexed to medical prices, eventually it will reach everyone. It’s also very regressive, applying a 40% rate to everyone, regardless of income. Minimum wage workers will be taxed as though they were millionaires.

Defenders say the tax will encourage more economical choices of insurance benefits. Yet the bill has a mandated benefit package that will be more bloated than most people realize. According to Kathleen Sebelius, it’s going to require real mental health parity rather than cosmetic parity and once special interests get geared up, the package will get more bloated over time. Adding to the price tag is a limit on the deductible and out-of-pocket exposure. And let’s not forget guaranteed issue and modified community rating regulations that push up premiums wherever they are implemented.

Bottom line: There is no serious attempt here to keep premiums low or to encourage bare bones health insurance. The Senate tax looks like a tax, acts like a tax, walks like a tax...

The McCain health plan, by contrast, would have substituted a new and better tax regime for the current one. People would be able to get all their tax benefits up front, by buying core insurance that everyone should have. Extra benefits would be completely paid for with after-tax dollars.

John McCain should never have allowed Barack Obama to characterize his plan as a tax increase. It was instead a tax cut for 90% of all workers. And it might have resulted in a tax cut for almost everyone, once people adjusted to it.

Moreover, the McCain proposal was highly progressive. Much more so than what has been proposed in either the House or Senate versions of ObamaCare.

­With Congress back in town for the new year, the Democratic majority has entered the endgame in resolving differences between the House- and Senate-passed versions of health reform. There are a number of differences to be reconciled, including how to pay for the overhaul. A major portion of the financing in the House bill would come from a surtax on the wealthy. In the Senate, an excise tax would be levied on high-cost health coverage (so-called “Cadillac plans”). At a minimum, the House is looking to raise the thresholds in the Senate bill to some amount above $8,500 for single coverage and $23,000 for family coverage. While any excise taxes would be paid directly by a combination of health plans and plan administrators, the expectation is that these taxes will be passed down to the families covered by these plans. Raising the thresholds would reduce the number of people affected by the excise tax, but future health inflation could push more into its clutches. Politically, a surtax does not likely conflict with campaign promises, an excise tax on high cost plans likely does.

Much has been written about taxes and health care (see http://www.ebri.org/pdf/briefspdf/EBRI_IB_1-2009_TaxCap1.pdf, http://www.ebri.org/pdf/briefspdf/EBRI_IB_09-20074.pdf, and http://www.ebri.org/pdf/briefspdf/EBRI_IB_06-20061.pdf). The excise tax is a blunt instrument designed to raise revenue. A health plan can have a high premium because it is a Cadillac plan – for example, one with first-dollar coverage (no cost sharing) and no restrictions on the doctors that can be seen or the prescription drugs that are available. A health plan can also have a high premium because the workers in the plan are older. An employer hiring 55-year-olds will pay much more for health coverage than an employer hiring 25-year-olds, even for the same plan. In fact a recent paper in Health Affairs (http://content.healthaffairs.org/cgi/content/abstract/hlthaff.2008.0430) found that only 6.1% of the variation in premiums was explained by differences in plan design and plan type.

The use of health care is different than the consumption of other goods and services. Most people are healthy and do not use a lot of health care. It is well established that 20% of the population uses 80% of the health care services provided in any given year. The bulk of the money goes towards treating people with chronic conditions, such as heart disease, cancer, lung disorders, mental health, hypertension, and diabetes. With an obesity rate in the U.S. at one-third and growing (it was 15% in the mid-1990s), the incidence of these diseases will only increase. The unanswered question is whether a tax on high-cost plans (driven more by incidence of disease than plan design) that reduces the comprehensiveness of plan design will reduce spending on health care services among the chronically ill. If a person with diabetes does not change his or her use of health care as a result of the excise tax, health care costs will not be affected, and the long held hope of economists that taxing high cost plans will reduce total health spending, and increase wages, could be proven wrong. Either way, the only thing that should be viewed as certain is that either approach will raise revenue to help pay for reform, and that, after all, is the primary reason they are in the legislation at this late stage of the process.