Abstract
The increasing cost of employer contributions for employee health insurance reduces the
percentage of compensation that is subject to the payroll tax. Rising insurance contributions can
also have a more subtle effect on the Social Security tax base because they influence the
distribution of money wages. Workers bear most of the burden of employer health contributions
through lower money wages. Any change in the average cost and distribution of costs of
employer health plans can have an effect on the distribution of wages and the percentage of
wages subject to the payroll tax. This paper uses the Medical Expenditure Panel Survey (MEPS)
to analyze trends in the cost of employer health contributions and the cross-worker distribution
of health contributions. Our analysis shows that the 1996-2008 increase in employer health
premiums was faster than overall compensation increases but only slightly faster among workers
below the taxable maximum compared with those above the maximum. However, because
employer health insurance premiums represent a much higher percentage of compensation below
the maximum taxed earnings amount, the effect of health cost trends exerted a disproportionate
downward pressure on money wages below the taxable maximum, reducing the percentage of
compensation subject to the payroll tax. We simulated the implications of the health reform law
on the trend in employer health costs around 2016. We find only slight effects on the fraction of
worker compensation that will be subject to Social Security taxes. The higher insurance costs
faced by employers who will be required to offer health plans will be approximately offset by
lower health costs on the part of employers who will see some insured employees accept
subsidized health insurance outside of an employer plan. The main long-term impact of reform
on the taxable wage base is likely to be through its effect on the trend in underlying health care
costs.
Executive summary
Over the past six decades U.S. health care costs have increased much faster than
employee compensation and consumer prices. Over that same time span American employers
assumed a growing role in insuring their workers’ health care expenses. The great majority of
wage and salary workers and their dependents now receives health insurance through an
employer-based plan. Even when the expansion of employer coverage ended and the
liberalization of employer health plans ceased, employer outlays on workers’ health consumption
continued to grow as a result of increases in health care prices and utilization. Employer
contributions for employee health plans increased from 0.5% of compensation in 1950 to 3.7%
of compensation in 1980 and to 7.0% in 2010. Since 1980 all the decline in the ratio of money
wages to total employee compensation has been due to the rising share of employee health
benefits in compensation.
These trends have important implications for the Social Security tax base. Money wages,
but not employer contributions for health benefits, are included in taxable earnings. Under the
assumption that workers ultimately bear the cost of employer-provided health benefits through
lower wages, the continuing rapid growth in health costs reduces the share of employee
compensation included in the tax base. In recent decades the outsize growth in health costs has
been accompanied by a rise in wage and compensation inequality. Workers at the top of the
wage distribution have seen faster increases in wages and compensation than workers in the
middle and at the bottom of the distribution. Growing wage inequality reduces the Social
Security tax base, because it increases the proportion of wages above the taxable earnings
ceiling.
This paper examines the relationship between rising employer health costs and growing
wage inequality using wage and insurance premium data in the Medical Expenditure Panel
Survey (MEPS) household and employer survey files. Health insurance coverage is offered to
employees earning high wages more frequently than it is to workers with low wages, and take-up
rates also are higher for workers earning high wages. Nonetheless, the average cost of employer
health plan contributions represents a larger percentage of wages for low- and moderate-pay
employees than it does for workers earning higher wages. In 2007 and 2008, for example,
employer health contributions represented 10% or more of the average pay of workers in the 2nd
through the 7th wage deciles but less than 5% of the wages of earners in the top one-tenth of the
wage distribution. These averages include both earners who are insured under an employer
health plan and workers who are not offered coverage or who decline to enroll in their
employer’s plan.
During the years we analyze, 1996-2008, we find only modest changes in the insurance
coverage of wage and salary workers and somewhat larger changes in the percentage of workers
who opt for more costly, family plans. The proportion of workers who enrolled in more costly
plans fell in every wage decile. Nonetheless, employer outlays on employee health plans rose
considerably faster than wages in every part of the wage distribution except among the bottom
one-tenth of wage earners. In the top 80% of the wage distribution, we find that employer
contributions for employee health plans increased at approximately the same rate, about 6.9%
per year. However, employer health premiums represent a larger percentage of total
compensation in the middle and near the bottom of the distribution than they do at the top.
Consequently, the growth in employer health costs absorbed a larger percentage of compensation
gains in the middle and at the bottom of the wage distribution – except at the very bottom –
compared with the top of the distribution.
Differences in the rate of growth of wages tended to reinforce this differential effect of
rising health costs. Wages grew faster at the top of the distribution, especially above the Social
Security taxable wage ceiling, compared with the middle and bottom of the distribution. Over
the historical period we analyzed, national health spending and wage statistics show that
employer health insurance premiums per worker increased 5.77% a year, while annual money
wages increased 3.93% a year among earners with wages below that taxable maximum and
4.50% a year among earners with wages above the maximum. In simulations we find that the
combined effect of rising health costs and increased wage inequality was to reduce significantly
the share of Social-Security-taxable wages in employee compensation. Among earners with
wages below the taxable wage ceiling we estimate that increased employer health costs reduced
the fraction of compensation consisting of taxable wages by 1.43 percentage points between
1996 and 2008. For earners above the taxable wage ceiling the combined effect of rising health
costs and growing inequality reduced the share compensation that was taxable by Social Security
from an estimated 44.9% to 42.2% of compensation. If employer health costs had instead
increased in proportion to the rate of compensation increase above and below the taxable wage
ceiling, the Social Security tax base would have been 1.7% larger in 2008. We project that the
tax base would be 3.8% larger by 2020 if employer health costs grew between 1996 and 2020 at
the same rate as employee compensation.
We also estimate the potential effects of the Affordable Care Act on money wages and
the Social Security tax base in 2016, a year when the major provisions of the Act are scheduled
to be fully implemented. In making our estimates we ignore the possible effects of the law on
the trend in overall health costs. We take this trend as given and estimate the impact of reform
on the sources of employee health insurance coverage. The 2010 health reform law is expected
to increase the proportion of working-age adults and their children who are insured. Some of the
increased coverage will occur because more large employers will be induced to offer health plans
to their workers, in part because of the financial penalties they face if their full-time employees
obtain government-subsidized insurance. Other increases in coverage will occur because
Medicaid income eligibility limits are increased, boosting the percentage of workers and worker
dependents eligible for government insurance. Finally, other uninsured workers will obtain
insurance through state health insurance exchanges, which are expected to make affordable
health plans available to a wider cross-section of working-age adults. Some workers in low- or
moderate-income families will be eligible for public subsidies to help pay for insurance plans
purchased through an exchange, encouraging some of them to switch out of employer plans.
Under the maintained assumption that total employee compensation will remain
unchanged for each worker, we calculate the effects of changes in the source of health coverage
on the division of employee compensation between money wages and employer contributions for
health insurance. On balance we find that health reform is likely to increase employee
compensation in the Social Security tax base, though only by about 0.3%. The main reason is
that some employers of low- and middle-wage workers are likely to see some of their
employees switch into subsidized insurance plans provided through Medicaid and health
insurance exchanges. Because these employers will be relieved of the burden of contributing as
much to their group health plans, they will be able to offer higher wages to affected employees.
To be sure, some employers which did not previously provide insurance to their workers will be
induced to offer health insurance. Doing so will be less expensive than paying the fines that are
specified in the Affordable Care Act. These employers will have to reduce money wages to
compensate for their higher health care costs, thus reducing the fraction of compensation they
pay as Social-Security-taxable wages. Averaging across all workers, however, the money wage
increases received by employees who impose lower health costs on their employers are likely to
more than offset the higher health contributions for workers who gain access to an employersponsored
health plan. The net effect on Social-Security-taxable wages is likely to be small.
The more profound effect of health reform on taxable employee compensation will
probably occur through a different channel. If insurance reform leads to slower long-term
growth in health care spending, a larger fraction of future compensation will take the form of
money wages.
