The problem of rising healthcare costs cannot be fixed by the current prescription of redistributive policies. Policymakers must redirect their focus.
Concern about income inequality has dramatically shifted public attitudes toward economic and fiscal policy, and the subject of inequality has increasingly dominated the political debate. In fact, President Obama called inequality “the defining challenge of our time.” This discussion has focused almost exclusively on comparing the earnings of lower- and higher-paid workers, and on promoting redistributive policies aimed at “correcting” this disparity—a focus that has been fueled by the works of economists such as Thomas Piketty and Emmanuel Saez. Both scholars and politicians, however, have largely overlooked a key contributor to earnings inequality: the role of rapidly increasing healthcare costs.
Most previous analyses of inequality focused exclusively on earnings, ignoring total compensation (including healthcare benefits). This oversight significantly inflated the perceived severity of workers’ earnings inequality. Furthermore, past economic analyses have largely focused on how increasing healthcare costs drive burgeoning government spending, slow growth in worker earnings, and cause later retirements. But very few have recognized the growth in healthcare insurance premiums as a cause of increasing earnings inequality.
In a recent research for the Mercatus Center at George Mason University, I analyzed the link between earnings inequality and rising healthcare costs using unpublished data from the Bureau of Labor Statistics. I found that the increasing cost of employer-provided healthcare benefits accounts for a significant portion of rising earnings inequality.
This can be explained by looking at the share of healthcare costs relative to total compensation, which are much higher for low earners than for high earners. Rapidly growing healthcare costs, therefore, increasingly eat away at wage growth and non-health benefits—particularly for low-wage earners. To get some idea of the scale of escalation in healthcare costs, data from the 2015 Kaiser Family Foundation Survey highlights how employer costs for family healthcare coverage have exploded in recent years from around $4,200 in 1999 to nearly $12,600 in 2015. When we account for this increase in healthcare costs as a share of earnings for low-income workers, it becomes clear why the wages of low-income workers have stagnated in recent years.
Looking at data from 1996 to 2008, I found that unlike earnings, overall compensation (which includes healthcare benefits) did not become more unequal. In fact, overall benefits grew more quickly during this period for low-paid workers than for the top 1 percent. Thus, without rising healthcare costs, there would have been virtually zero change in earnings inequality.
Both economic theory and empirical findings indicate a clear tradeoff between wages and benefits: as benefits become more expensive, employers tend to hold back on salary increases, and so wage growth ultimately suffers. In fact, according to simple regression analysis, for every one percentage point increase in the healthcare cost share of compensation, the annual rate of growth in earnings declines by 0.23 percentage points. Over the period of 1990 through 2014, surging healthcare costs depressed annual earnings growth for low-paid workers more than twice as much as for the top 1 percent of workers.
Policymakers and researchers thus far have focused on disparities in income but have failed to recognize the changes in compensation—or, as is key, the cause of the change. The problem of rising healthcare costs—and its negative effects on earnings—cannot be fixed by the current prescription of redistributive policies. Policymakers must focus on the primary driver of the problem and redirect their focus to reducing the rapid growth in healthcare costs, because there is ample evidence of significant waste in healthcare spending, both in reality and in the perception of workers. Positive steps toward this end include reducing the highly favorable tax treatment given healthcare spending and insurance and strictly enforcing anti-trust law in the healthcare sector. Further, policymakers should aim to encourage employers and government programs to provide insurance coverage that has more scope for consumer sensitivity to costs.
(Note: Mark J. Warshawsky is a Senior Research Fellow at the Mercatus Center of George Mason University. His research interests include employer-sponsored pension and retirement programs, social security, financial planning, health and long-term care financing, corporate and public finance, and macroeconomics.)