Health Insurance Labor Economics

Increasing health insurance prices and worker compensation

Economists typically assume that the majority of additional costs employers incur from hiring a worker are reflected in a lower compensation package for the employee.  For instance, employees owe payroll taxes for Social Security and Medicare on 7.65% (Social Security taxes are limited to earnings below $94,000 in 2006, but Medicare taxes are applied on all earnings).  Employers also pay a tax of 7.65% of workers wages to the government.  Economists believe that the true tax to workers is 15.3% since firms pass on the added costs to employees.

Increasing health insurance costs is another arena where employers may pass the costs on to employees.  A study by Goldman, Sood and Leibowitz (2005) analyzes how wages and benefits change in response to rising health insurance costs at one specific benefits consulting firm with a ‘cafeteria plan’.  The firm pays workers a wage and gives them a credit towards the purchase of a variety of benefits.  The credit can be used towards acquiring health insurance, as well as other benefits such a pension, accident insurance, life insurance, long term disability, etc.  The credit the firm grants to workers is based on their salary and their tenure at the firm.  Workers who wish to receive more benefits above their credit allocation can pay for the difference out of their salary.

Using a fixed-effects model with data between 1989-91, the authors estimate how changes in the price of health insurance affected the workers choice of benefits.  They find that when the price of health insurance increases by $1, workers finance the increase with a 52 cent reduction health insurance expenditures, a 37 cent reduction in take home wages, and a 17 cent reduction in other benefits.  This result shows the demand for health insurance is inelastic since a price increase leads to increased expenditures–48 cents in this example–on the good.

A problem with the study is the narrowness of its scope.  Since it only deals with one white collar firm, this result may not be generalizable to other sectors or the economy as a whole.  Also, the authors claim that as employees reduce the amount of other benefits as health care prices rise, an employee may be more vulnerable to health, mortality, disability and other risks.  We do not know, however, whether or not the employees decided to increase their savings rate in the face of decreased benefits in order to ‘self insure’ against future risks.  Thus the magnitude and sign of the change in an employee’s vulnerability to future risk is indeterminate.

Source: Dana P. Goldman, Neeraj Sood, and Arleen Leibowitz (2005) “Wage and Benefit Changes in Response to Rising Health Insurance”, Forum for Health Economics & Policy, Forum: Frontiers in Health Policy Research, Volume 8: Article 3.