Marginal Labor Income Tax Rates under the ACA

I was a discussant of Casey Mulligan’s paper Average Marginal Labor Income Tax Rates Under the ACA at the UNC Tax Symposium hosted in Chapel Hill, NC by Doug Shackelford this past Saturday. His figure 3 summarizes changes in the marginal tax rate of labor income over the past 7 years, accounting for both explicit and implicit taxes for someone with median wages. For example, in 2014, there is an increase in the marginal rate due to a reduction in work incentive that occurs for someone with median wages because premium subsidies are based on a income-linked sliding schedule-an implicit tax on earning more because you lose insurance subsidy as you earn more income. The paper also identifies increased implicit incentives to work more, for example, the fact that exchange subsidies cannot flow to those below 100% of poverty.

All of the impact is not due to the ACA; it is the cumulative effect of all explicit and implicit taxes on labor income. For example, the increase from 2012 to 2013 was due to the ending of the payroll tax holiday. The increase from 2013 to 2014 is the onset of the ACA subsidies that increase the marginal tax on labor income as noted above. The step up in 2015 shows the incremental impact of the employer shared responsibility penalty, aka employer mandate, that was delayed in 2014. The dashed red line shows what the effective marginal rate would be if the emergency unemployment compensation was allowed to expire at the end of 2013, which is precisely what has happened, so the dashed 2014 line is what exists today, with an increase next year if the employer mandate goes into effect (I predict the employer mandate penalty never takes effect, just like in Massachusetts).

Here are the slides UNCtaxconference.1.18.14 that I showed at the conference that contain some suggestions (such as evaluating the effective tax rate at different income levels), criticisms (not accounting for the loss of the tax subsidy one forgoes when exiting ESI for exchange subsidies) and the broader policy framing that I think the paper deserves. On the whole I think this paper that makes a heroic effort to provide tangible estimates of the intuition that is obvious if you have a subsidy the declines with increasing income, or which drops to zero with small changes in income (going from 400% of poverty to 401%). The equally obvious solution if your goal is to minimize the marginal tax rate of labor income is to provide a more uniform subsidy, but pressure to reduce the cost of the subsidy is what lead to the structure in the first place, so there is a tradeoff at work.

Of all the suggestions I made to Casey the one I most wish he would follow would be to analyze the impact on marginal labor income tax rates of different means of financing the ACA. For example, do away with employer mandate and finance it via a VAT or sales tax? A straight payroll tax? Capping of the tax exclusion of ESI and moving over time to end it? Etc. It would be fascinating to see the mix of alternatives that could finance the existing subsidy structure, not as a means of his saying he supported that structure, but to demonstrate the impact of the different options on the effective tax rate on labor income, whichCasey cares deeply about. Finally, a flatter subsidy could be evaluated that would help to demonstrate the tradeoff between increased cost of a subsidy, and the impact on labor income tax rates.

Such a paper would be extremely valuable.

[Cross-posted at The Reality-Based Community]

Don Taylor

Don Taylor is an associate professor of public policy at Duke University, where his teaching and research focuses on health policy.