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Increases in health care costs are coming out of workers’ pockets one way or another: The tradeoff between employer premium contributions and wages

Increases in health care costs are coming out of workers’ pockets one way or another: The tradeoff between employer premium contributions and wages
Laurel Lucia
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This is the seventh post in the Labor Center’s blog series “Rising Health Care Costs in California: A Worker Issue.”

Our prior blog posts have discussed the challenges faced by some California workers with job-based coverage in affording their share of premium contributions and out-of-pocket costs. These health care costs are highly visible to workers because premium contributions are deducted on workers’ paystubs and out-of-pocket costs are paid directly at the point of care or through medical bills. However, the lion’s share of the cost of job-based health coverage is paid by the employer. The Kaiser Family Foundation calculated that employers were responsible for two-thirds (66 percent) of total health expenditures on average for U.S. workers with family coverage through a large employer in 2018.

Employer premium contributions are a hidden cost for workers

Although combined employers’ and workers’ expenditures on health insurance premiums are now reported on W-2 forms, the amount employers spend on insurance is less evident to workers than the health care costs they themselves pay directly. But employer contributions are of consequence to workers, and this fact becomes clearer when employer contributions are viewed as a portion of broader compensation.

Under traditional economic theory, employer contributions to health insurance premiums are one of many parts of workers’ total compensation, and employers offer the combination of wages and benefits that will best help them attract and retain employees. (Employers also value health insurance because it helps improve workers’ effort and productivity.)

Employer contributions to health insurance can make up a significant portion of total compensation. For example, for a family earning $70,000—the median family income for California workers—the $15,730 average California employer contribution to family health coverage comprises 15 percent of total compensation.*

In their recent book The Triumph of Injustice, UC Berkeley economists Emmanuel Saez and Gabriel Zucman describe job-based coverage premiums as a giant hidden tax on workers, but which is paid to insurers rather than the government. They argue that health insurance premiums reduce wages like a payroll tax and that, like payroll taxes, health insurance premiums are essentially mandatory because the Affordable Care Act (ACA) requires large employers to provide health insurance or pay a penalty. According to Saez and Zucman, health insurance premiums “reduce wages in a particularly unfair way: Because health insurance premiums are fixed, the wage penalty is the same for a low-wage secretary as it is for a highly paid executive.”

Employers can pass on rising health care costs to workers in multiple ways

When health care costs rise, employers can respond in a variety of ways, such as by increasing worker premium contributions, increasing deductibles or copayment amounts, reducing employment, or increasing their own premium contributions while reducing or limiting wage growth accordingly. Research by Sommers (2005) suggests that firms respond in multiple ways to rising health costs—not only by reducing wages but also by reducing employment, making benefits less generous, and requiring larger worker premium contributions. At least two studies (Anand 2017 and Lubotsky and Olson 2015) have found that rising health care costs primarily result in higher worker premium contributions, as opposed to reductions in wages. Other studies (Sommers 2005, Baicker and Chandra 2006, and Sood, Ghosh, and Escarce 2009) have found associations between rising health care costs and reduced employment, while Lubotsky and Olson (2015) found no impact on employment.

A tradeoff between wages and employer premium contributions exists, but it is not necessarily dollar-for-dollar

Economic theory indicates that any increase in health care costs not passed through to workers via higher premium contributions or out-of-pocket costs will come out of workers’ wages or other compensation over the long-run, but the empirical research demonstrating the tradeoff between wages and rising employer premium contributions is mixed.

Some studies have found that employers’ total spending on health care has a substantial impact on wages (see, for example, Gruber and Krueger 1991, Sheiner 1999, and Kolstad and Kowalski 2016). Other studies have shown that incremental increases in health care costs can impede wage growth (see, for example, Gruber 1994, Baicker and Chandra 2006, and Clemens and Cutler 2014). But other studies have failed to find a relationship between wages and health benefit costs (see, for example, Levy and Feldman 2001 and Lubotsky and Olson 2015). None of the research has examined the effect on wages if health care costs fall instead of rise (see box below).

What if health care costs fell?

This blog post focuses on the evidence related to how employers pass through increasing health care costs to workers in our current system. It does not address how wages would change if job-based health insurance costs are reduced or eliminated. This is an important question that has arisen in the national discussions about Medicare for All, but one that remains unaddressed in the research literature.

Saez and Zucman argue that adopting a Medicare for All system would result in a large wage increase for workers if the government mandates that employers convert premium payments to wages in order to ensure full pass-through of the savings to workers. A strong union can also be a mechanism for workers to capture the savings from containing health care costs in the form of increased wages.

Among the studies finding a dampening effect on wages, the evidence is also mixed on the size of the effect—a one dollar increase in health care costs does not necessarily result in a worker with job-based coverage receiving exactly one dollar less in wages than they otherwise would have received.

Employers incorporating the rising cost of health care in wage decisions are more likely to forego raises that would have otherwise occurred than to reduce nominal pay. Reducing workers’ wages in absolute terms is largely avoided by employers, since doing so could result in increased worker turnover and reduced productivity. For similar reasons, employers may reflect the high cost of health care more fully in the salaries offered to new employees compared to existing employees.

The extent to which rising health care costs impede wages also depends on the nature of each worker’s employment, their bargaining power, and other labor market dynamics. For example, research by Qin and Chernew (2014) and Clemens and Cutler (2014) suggests that having a union can buffer workers from the full effects of health care costs being passed through to wages. For a variety of reasons, public sector employers may be more likely to absorb some of the cost of rising health care. Additionally, in a tight labor market with low unemployment, employers may be more likely to absorb health care costs in ways that don’t reduce compensation.

While the research findings have been mixed on which levers employers rely on most to respond to rising health care costs as well as on what the net impact on wages has been, the bulk of the research literature indicates that, one way or another, most of the burden of ever-increasing health care costs falls on the shoulders of workers. That burden may come in the form of lower wages, higher premium contributions, or higher out-of-pocket costs. All these impacts are likely to have more severe consequences for low- and moderate-income workers, but rising health care costs affect the economic well-being of all workers with job-based coverage.

Up next: Our next blog post will discuss how high prices are the primary driver behind the increasing burden of health care costs faced by California workers.

* This example assumes that all benefits other than health insurance, such as paid leave, retirement, employer-paid payroll taxes, workers’ compensation, etc., add 32 percent to wages, using the Bureau of Labor Statistics national average for private sector workers.