New health care act presents financial issues for both employers and employees
Alternatively, the employer may pay a penalty of $2,000 for each full-time employee. Section 4980H(c)(7) refers to the penalty as a tax, and makes clear that these $2,000 payments are nondeductible. As a result, for an employer in the 40 percent tax bracket (combined federal and state), the $2,000 nondeductible payment would be equivalent of paying approximately $3,300 of additional wages for each full-time worker.
Except for minimum wage workers and those covered by existing labor contracts, the new mandates and penalties do not require any minimum amount of total employee compensation. The rules only require that the total compensation package, whatever it is, include a minimum amount of employer-subsidized insurance. Thus, there is no health act or tax law prohibition on reducing otherwise applicable cash salaries or benefits to compensate for the added costs of providing health insurance or paying a new per-job penalty to the government. In the case of minimum-wage employees, however, the new mandates and penalties will necessarily increase the payroll costs of employers not currently providing insurance, unless those positions become part-time jobs which are not covered by the new law.
In the long run, because the employer's total payroll costs for each employee will increase, these new requirements could depress the levels of cash compensation paid to employees of companies with more than 50 employees. Such wages may decline or slow their rate of increase. If cash payroll costs for smaller companies are similarly affected in a competitive labor market, the net effect may be a tax subsidy for small companies. That is because the health insurance costs of their employees will be subsidized directly by the taxpayers through refundable tax credits, while large employers will bear those costs themselves.
Also assume that the business is considering the creation of a new division that would require the hiring of:
In all cases, assume that the workers have spouses receiving identical salaries at other companies. The following discussion details how those prospective new hires may be affected by the new law.
Higher-wage workers may be unaffected
Lower-wage workers may face reduced take-home pay
If an employee accepts the insurance the employee's disposable income will automatically decline due to the required payment of the employee's portion of the insurance premium. Without insurance, the employee's household (comprised of two spouses earning the same salary) would face income and social security taxes of approximately $7,000 leaving $38,000 of disposable income. After paying the $4,000 premium through a pre-tax premium payment plan (paid by one spouse or the other), they would be left with $34,000.
The effect on the employer must also be considered. Assuming that these employees would otherwise decline coverage, a decision to elect coverage would increase the employer's average total cost of hiring such workers from $22,500 to $26,500 -- plus, in both cases any FICA or other payroll taxes imposed on the employer. That $4,000 additional cost is attributable to the expectation that approximately half of the new workers will elect to be covered under their spouse's plan. Thus, the added cost of $8,000 per married couple will tend to be shared by both employers. Again, this assumes that none of the employees would have elected coverage before passage of the health care act, but are induced to do so by the individual mandate. In fact, a considerable number of lower wage employees do currently elect such coverage. As a result, this hypothetical may overstate the average increase in employer payroll costs triggered by the health care act and its individual mandate.
These new payroll costs, whatever they ultimately amount to, may affect the employer's business planning. It may seek to pass on the added costs in higher prices. If that is not possible, it may seek to offer the new employees lower cash wages. Remember that the employer will be fully in compliance with the health care act if the new jobs provide only $18,500 of gross cash wages, plus $12,000 of insurance for which the employer pays his required share of the premiums.
The reason that cash wages may decline for this group of workers, but not higher income workers, is that many more members of this group currently tend to decline health insurance, thus saving the employer money and allowing it to provide them with more cash wages. Once these workers are induced (as the legislation intends) by the individual mandate to elect health insurance they previously declined, the total payroll costs for them will increase, and their cash wages may decline or increase less rapidly in the future to compensate.
If wages decline by a total of $8,000 per married couple, an admittedly extreme hypothetical, the employer's required share of insurance premiums would increase slightly due to the decrease in cash wages. Still, an employee with $37,000 of household income could be required to pay $3,515. Thus, the employer's cost per policy would be $8,485 or an average of $4,242 for the half of its workforce that is expected to elect coverage with the employer, rather than obtaining insurance through a spouse's employer.
In the event of such a reduction in pre-tax cash wages the employees' cash flow after taxes and health care would obviously be more severely affected by the health care act. For a married couple with equal wages, the effects are as follows.
Recall that if their cash wages were not reduced and they did not elect insurance coverage they would have approximately $38,000 of after-tax cash. In addition, under the new rules, we assume that only one spouse would purchase an employer's policy. Thus, the total premiums the couple would pay would be $4,000. That would reduce after-tax cash to $34,000.
The next part of the analysis is a little complicated. If each of the employers had half of their employees buying a policy, with the other half obtaining it from a spouse's employer, each employer's insurance costs for those employees would increase by approximately $4,000 per employee. That is $8,000 per policy, divided by two. Again, that is because the cost of covering the workers as family members is shared by two employers.
If cash wages for all of those employees were reduced by the employer's average added insurance costs per worker (either immediately or over time, and perhaps simply by failing to increase cash wages with inflation), the couple's combined gross salaries could decline (in real dollars) from $45,000 to $37,000. That decline is a full $8,000 because there are two employees in the family, each expected to suffer a $4,000 decline in cash wages. After subtracting approximately $5,600 of combined FICA and income taxes, and $3,500 of cash insurance premiums (considering the 9.5 percent of household income maximum employee cost), they would be left with total household take-home pay of $37,000 less $5,600 less $3,500 or approximately $27,900. That is a reduction in their take-home pay from $38,000 (under current law, without any purchase of insurance) to $27,900, a reduction of $10,100. In exchange, however, they would receive the benefit of an insurance policy costing $12,000. Such an extreme reduction could be anticipated only if virtually all of the workers in this category currently decline insurance but are induced to elect it by the individual mandate.
Minimum wage workers may become part-time employees or be outsourced
For full-time employees, the employer could also choose to pay the per-job penalties instead of providing subsidized health insurance. Paying the penalty, in lieu of providing health insurance, could save some money. There could be added costs, however, to raise the cash wages of higher-income workers losing their health insurance benefits.
The employer could also provide insurance that is deemed "unaffordable" to some of its employees because it requires them to pay premiums greater than 9.5 percent of their household incomes. In that case, the penalty is the lesser of $2,000 per employee ($3,300 salary equivalent) or $3,000 for each employee that obtains subsidized insurance through a state-run exchange ($5,000 salary equivalent). If the employer anticipates that many low-wage or minimum-wage employees will choose not to purchase any insurance, even at the exchanges, then that may be a more cost effective option. However, it should be noted that the required employee payment at the exchanges will be far less than 9.5 percent of household income. Consequently, employees who might not purchase insurance at work might well purchase it at an exchange.
Will employers drop coverage in favor of paying the penalties or taxes?
It is not clear how many employees work in companies that actually have workforces similar to what the CBO/JCT consider average workforces. For example, a restaurant chain or retail chain may have predominantly lower-wage workers, while a pharmaceutical company that performs only research in the U.S. and manufactures its drugs overseas may have predominantly high-wage workers. In addition, the CBO and JCT have provided only limited analysis of the likelihood of companies spinning off (or franchising) lower-wage divisions or departments. There are related party rules, and draconian anti-discrimination rules, that limit the ability of commonly controlled or operated entities to be treated as separate employers, but those rules may not apply to a bona fide spin-off or sale of a going concern.
Will employer penalties be increased in the future?
Under the new health care act, a two-earner family of four making $45,000 will be eligible for a federal grant of close to $9,500 to help them pay for a $12,000 insurance policy. That is the equivalent of a more than 20 percent raise – in tax-free dollars – paid for entirely by the federal government. Families of four earning as much as $88,000 will be eligible for grants close to $3,500, and those earning only $22,100 will be eligible for grants as high as $11,500. According to the IRS, there are at least 90 million tax returns reporting family income from salaries low enough to be eligible for these subsidies. If only $3,000 were claimed by each such family, the total cost to the budget would be $270 billion. In contrast, the CBO and JCT estimate that only $70 billion of subsidies will be applied for and provided. The gap is evidently attributable to the assumption that very few employers will drop coverage and that most employees of large employers will not utilize the exchanges.
If the cost of the new subsidies is higher than was estimated – because more large employers drop coverage or spin-off or outsource their lower-wage departments or divisions into new companies that fail to provide coverage – Congress may decide to increase the employer penalties either to raise revenue or to induce more employers to offer insurance instead of paying the tax or penalty. For example, increasing the penalty from $2,000 per worker to $3,000 per worker (the equivalent of approximately $5,000 of additional wages) might equalize the costs of maintaining or dropping insurance, even for employers with predominantly low-wage employees. That would tend to reduce the number of workers using the exchanges and the associated revenue costs. Thus, it is not unreasonable to anticipate that the current level of employer penalties may increase.
Congress might also consider reducing the gross costs of the least expensive "bronze" policy employers must purchase, while maintaining the currently mandated level of employer penalties or taxes. If that were done, the costs of providing insurance would more frequently be less than the cost of paying the employer penalties or taxes for not providing insurance.
Effects on small employers
This is the most intriguing aspect of the legislation. If that occurs, the beneficiaries of the health care subsidies ostensibly provided for individuals may end up being small employers. They may see their labor costs decline as a portion of their employees' total compensation package is effectively paid by the federal government.
For additional information read our recent insight Supreme Court Largely Affirms Affordable Care Act.
This article represents the views of the author or authors only, and does not necessarily represent the views or professional advice of McGladrey
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