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Rethinking Employer-Based Benefits

The Huffington Post The Huffington Post 13/10/2015 Douglas Holtz-Eakin

Many Americans receive a long list of important benefits through their employers: life insurance, long-term disability insurance, accident and sickness insurance, dental/vision insurance, dependent care, flexible spending accounts, health insurance, legal assistance, free parking/parking subsidies, supplemental Medicare premiums, tuition reimbursement, and .... the list goes on.
In part, this is an accident of history. World War II wage and price controls precluded employers from giving the raises needed to hire and retain workers, but the central-planning bureaucracy decided that providing health insurance did not qualify as wages and, thus, not subject to tax. Employers had a way to give raises and the untaxed-fringe-benefit genie was out of the bottle.
It is also, in part, bad policy. If workers are paid in cash, they can choose the benefits they value and want - not what their firm's HR department dreams up. Even worse, because they are not taxed, benefits are a "cheaper" way to reward employees. The result is a bias against growth in cash wages and toward growth in benefits. Finally, the exclusion from taxes is a disguised subsidy - it represents genuine "spending" through the tax code - and the subsidy gets larger as tax rates go up; i.e., the subsidy is bigger for the more affluent.
Nevertheless, the drumbeat for more employer-based benefit continues. The most recent addition to the list is paid family leave. The District of Columbia got headlines for a proposal that everyone be entitled to 16 weeks of paid family paid for by a new payroll tax. Senator Bernie Sanders would mandate employers to provide at least 12 weeks of paid family and medical leave, while Secretary Clinton would "fight for paid family leave."
Notice that none of these approaches use the traditional tax subsidy. Instead, the DC approach is a classic tax-and-spend, pay-as-you-go entitlement program that could have been designed in the 1930s. In contrast, the Sanders proposal would mandate that employers provide, at their expense, the family leave. Characteristically, it is not clear which approach Secretary Clinton would pursue.
Still, these approaches inevitably hurt the growth of wages. The mandate is the easiest to see. It directly raises employers' labor costs, providing an incentive to recoup those increases by slowing the growth of other parts of the labor budget -- namely, wages. For this reason, the research literature broadly recognizes that mandated benefits come out of wages over the longer term. A similar finding prevails for payroll taxes. In Social Security, for example, the payroll tax is in principle evenly divided between employers (6.2 percent) and employees (6.2 percent), but the data indicate that wages are lower by the full 12.4 percent of the payroll tax. The new 1930s entitlement would have the same economics as the old 1930s entitlement.
Perhaps it's time for another approach. The "pure" policy approach would be to eliminate the tax subsidies, tax-based entitlements, and heavy mandates. But it seems clear that the political climate would not support a purely market-based provision of such benefits.
The alternative is to cap the taxpayer exposure to providing benefits and put workers in charge of the kinds of benefits they receive. Using White House estimates, the exclusion from tax of employer-provided benefits will lower receipts by roughly $235 billion in 2015. This translates into an average of roughly $35,000 of benefits for each of the 142 million working Americans.
Of course, not every worker gets $35,000 of benefits, but one could imagine setting a "budget" or cap for tax-preferred employer benefits of $35,000 for each worker. Or, one could design a set of caps that rose with wages and salaries, but which averaged $35,000 per worker.
For the worker making, say, $50,000 with a cap of $35,000, the employer could provide health insurance that was generous enough to trigger the Cadillac tax ($28,000 for the family policy) and paid leave for 7 weeks ($7,000). These benefits would be tax-exempt.
Or, the individual could tell the employer that she preferred 16 weeks ($16,000) of paid family leave, but a less elaborate ($19,000) health insurance plan. Or, she could opt for employer help with child-care expenses ($8,000), health insurance ($19,000) and a shorter leave of 8 weeks ($8,000). As long as the total remains within the cap, the employee gets what she wants, the employer faces the same labor costs, and there is no tax liability.
It is possible that the employee wants a lot of benefits - $19,000 for health insurance, $16,000 for leave, and $8,000 for child care - and the employer values the employee enough to provide all three. The total of $43,000 would exceed the cap by $8,000. This $8,000 would be included in taxable compensation and the employee would be liable for the tax on it. This would be fine; the employee voluntarily has chosen to pay a tax because she favors a benefit-rich compensation package.
Notice that the capped approach instills an incentive for efficiency in delivering fringes. One would not want, for example, the health insurance benefit steadily crowding out life insurance, transit subsidies and paid leave. Employees and employers will have better incentives in choosing plans and networks.
Second, this system will no longer encourage additional benefits at the expense of wages. As long as benefits stay in the cap, rises in productivity can be rewarded entirely in wages. Nor will it impose onerous taxes and mandates that damage take-home pay. Finally, it will permit benefits to reflect the desires of American workers instead of inefficiently providing benefits that workers do not value.
The demand for new benefits is real. But so must be the demand for a new approach to providing them.

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