Bryan Caplan  

Mandated Benefits and Wage Rigidity: The Effects of the "Fair Share Health Care Fund Act"

PRINT
Maryland, Wal-Mart, and Health... Mind Wide Open...

Economists are lambasting Maryland's "Fair Share Health Care Fund Act", which effectively forces Wal-Mart to spend at least 8% of its payroll on health care. While I'm happy to join in the chorus, I nevertheless believe that many opponents of the legislation - and more than a few economists - need to refine their predictions about its effect.

The story I've heard from most opponents is: Wal-Mart will simply cut workers' wages to make up for the extra health-care cost. To be more precise, labor supply goes up and labor demand goes down, so the equilibrium wage must fall.

Figure 1

sd1.jpg

That sounds good, but I would be very surprised if Wal-Mart suddenly told its employees that, due to the new legislation, it was cutting their pay. That would be a sure way to alienate its whole workforce: "Unfair! Unfair!"

So does this mean that there are no ill effects for workers? No. The "don't cut wages" fairness norm works like a funny kind of price control. As long as market conditions are stable, it has no effect. But if legislation reduces the market-clearing wage, the result is a labor surplus. How big? You have to look at the difference between the new quantity demanded and the new quantity supplied at the OLD wage.

Figure 2

sd3.jpg

What? Look carefully at dashed line on Figure 2. It represents the "don't cut wages" norm, showing that wages cannot fall below their initial level. Now look at the red line. It starts at the intersection of the new demand curve at the old wage, and runs all the way to the intersection of the new supply curve at the old wage. Since the market-clearing wage has fallen, but the actual wage stays constant, workers now want to sell more labor than employers want to buy.

In the long-run, of course, Wal-Mart may circumvent the "don't cut wages" norm by raising wages at a rate lower than inflation. With 3% inflation and 1% raises, Wal-Mart could covertly cut real wages by 2% per year, gradually eliminating the labor surplus.

Overall, the people who say "Wal-Mart will just cut wages to make up for the extra health care costs" are actually optimists. The economic effects are likely to be a lot uglier. And so are the political effects.

How so? If the legislation just led to lower wages, there wouldn't be any "poster children" to put on the news. Affected employees would have less money and more health care - nothing to crow about.

But if my analysis is right, there will be some lucky workers who keep their jobs, don't immediately see their wages fall, and get extra health care. It will be easy to run a story that starts: "Economists said it would hurt workers, but meet Fred, a cashier at Wal-Mart..." So even after they do great damage, the politicians who voted for the Fair Share Health Care Fund Act will still be able to loudly claim victory.


Comments and Sharing





TRACKBACKS (1 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/431
The author at A Stitch in Haste in a related article titled From the Archives: Wal-Mart's Fight-or-Flight Decision writes:
    You can't claim not to have already known about the atrocious legislation in Maryland requiring every private employer -- all one of them -- with 10,000 or more employees to div... [Tracked on January 14, 2006 7:14 AM]
COMMENTS (30 to date)
Pedro Bento writes:

Remember that Wal-Mart will be considering how their actions will play in the press. If they think keeping wages constant, even for a while, will result in other districts passing similar legislation, they may want to go ahead and fulfill economists' predictions.

James writes:

I can see it now.

Pro-Regulation Person: See, Walmart and other big firms report higher worker productivity now that they pay for employee health care.

Anti-Regulation Person: That's because they are hiring less people than they otherwise would, so they are able to be more selective in who they hire.

Pro-Reg: But my reality-based view of the world doesn't have any way of counting the number of people that Walmart otherwise would have hired but for the passage of this new law.

Anti-Reg: There are lots of good reasons to believe that the demand curve for labor slopes downward, so it follows from this that Walmart would have hired more workers were it not for this law.

Pro-Reg: That's faith-based...

Paul Zrimsek writes:

Is there any reason Wal-Mart couldn't keep wages the same but deduct the additional cost from paychecks in the same way they'd deduct, for example, union dues? Having their employees see that "State-mandated supplemental health insurance" line on their pay stubs would make things pretty clear.

Squib writes:

I think it is a bit misleading to use a market supply and demand for labor. Walmart is not the sole demander of low-skilled labor. The legislation applies to Walmart, but not its competitors. The supply of labor to Walmart is likely to be very elastic, and it will shift down (at the margin) by less than the demand. Marginal workers value the health care less than it would cost Walmart, or it would already have been provided.

Expected long-run effects should be lower employment by Walmart, higher employment by its competitors (who don't have to "pay" for health care) and effects on the kinds of workers Walmart gets and its competitors get. Walmart will have (older?) workers who prefer health care to wages; its competitors those who prefer wages. Overall, compensation (wages plus health benefits)should be equalized in the long run.

Randy writes:

That's a great analysis, but I think Walmart's resistance will be more straight forward. They will file a law suit, stop work on the new distribution center, and immediately move to reduce their work force to stay under the limit. The Maryland legislature has effectively stated that it does not want the type of retail operation that can offer lower prices. Fine, they won't get them.

Randy writes:

Great idea, Paul!

Daveg writes:

Shouldn't the first graph really include a shift to account for the wage subsidy that was artificially pumping up the labor demand?

That is, the state was paying for the health care for Wal-Mart workers. Therefore, the state was artifically increasing the amount of labor Wal-Mart could hire.

Now, by forcing Wal-Mart to pay for the health care of the workers it brings in, the labor demand is returned to the true, uninflated, value.

This is clearly the desired outcome.

Paul Zrimsek writes:

Well, one possible drawback that's occurred to me since I posted it is that the money might become taxable if they do it that way. I don't know from tax law. Might be worth a try just the same.

Randy writes:

Daveg,

Healthcare is an individual responsibility first, a family responsibility second, and a socio-political responsibility third. It is not now, nor has it ever been a responsibility of the free market activities. Some businesses have, in the past, chosen to pay their workers in health care benefits instead of dollars, but as healthcare becomes more and more expensive, that choice will be less and less feasible.

Why should only employees of large companies get mandated health care benefits? This is a socio-political problem, and trying to solve it with Walmart is just plain stupid.

daveg writes:

Why should only employees of large companies get mandated health care benefits? This is a socio-political problem, and trying to solve it with Walmart is just plain stupid.

Randy, this may be the case in your mind, but in the "real world" there are laws that explicitly require YOU to pay for the healthcare of others. Any failure on your part to pay for the health care of your fellow citizen, along with a whole host of other services and benefits, will result in you being put in jail.

I am not opining as to whether this is good or bad, but I am saying that it "is".

You can try to ignore those laws. You can pretend they don't exist and have no real effect, but you would be doing just that - pretending.

These law should be treated like a force of nature, a physical law, from an economic standpoint, because they have that effect. People will act and conduct themselves based on the existence of these laws and you should too.

Any attempt to ignore these law during the corse of policy analysis or formation is as doomed to failure as someone driving down a road ignoring the existence of a cliff.

daveg writes:

Let me give another extreme example.

Let's say that the government creates a non-sensical policy such as paying people $0.05 for every soy bean. They just warehouse these soybeans until they go bad, but as we all know governments make bad law sometime. That's what they do.

As a result, people start growing soybeans like crazy and selling them to the government. 0 Once the government see that they will soon go broke they pass a law that says noone who hasn't grown soybeans in the past can start growing soybeans now.

While it is not the best solution, is does stop the economic bleeding and creates some stability.

Would some economist then claim that the government has no business preventing people from growing soybeans as this is just market activity and should not be regulated?

I certainly hope not.

It is the same situation with medical care. The government has said they will pay people to provide and consume health care, rather than soybeans. Stupid? Maybe, but that is the case.

This creates an opportunity for some to "game" the system like Wal-Mart who let the government pay for the resources consumed by their employees. After a while the state sees this is not sustainable and moves to force Wal-Mart to pay up.

Was that the best way to solve the problem? Probably not. Was it a way to solve the problem. Probably yes.

But either way, allowing Wal-Mart - along with a whole host of other companies that are much worse - to continue to game the system is not "free market" and is not sustainable.

James writes:

Daveg,

This law may be a solution to the free ride that employers enjoy, but if so, it's the wrong solution. The problem is that when government stops the bleeding the wrong way, well, the bleeding has stopped so no one is concerned about trying to deal with what caused the bleeding in the first place.

Really, it seems like the analysis you're offering is based on an arbitrarily constrained set of alternatives. I count at least four possibilities:

1. Subsidized health care with the Fair Share Act
2. Subsidized health care without the Fair Share Act
3. No subsidized health care with the Fair Share Act
4. No subsidized care and no Fair Share Act

You seem to want to reject the normative case for 2 and 4 because they are not descriptive of what the actual policy is in MD. Well, 3 isn't descriptive of MD's policy either, so by your standard we can rule it out. That leaves us favoring 1. But there is a problem here. When you constrain the set of alternatives to what presently is the case, then you cease to be dealing with any normative questions entirely.

Bernard Yomtov writes:

Two questions:

1. Doesn't this analysis incorrectly substitute cash wages for total compensation?

2. Doesn't the law mandate a change in the mix of compensation, rather than an increase in the minimum? I recognize that in the short run there is such an increase, but this goes away over time, since as Caplan points out WalMart can give smaller raises than it otherwise would.

Steve Sailer writes:

People without health care insurance just go to the emergency room when they feel sick. They say they can't pay, so the costs get added to the bills of everybody with health insurance.

By not paying for health insurance, Wal-Mart is just free-riding off the humanitarianism of most everybody else in the system.

It's bizarre that economists don't realize that. I think a big problem with economists is that they are too academic and don't understand how businesses think. Having been in the corporate world for many years, and having spent a year traveling to Bentonville to call on Wal-Mart, it's obvious to me what Wal-Mart is doing -- I'd try to do the same thing if I was in their shoes -- but most economists just don't seem to get it.

Ramon writes:
It's bizarre that economists don't realize that. I think a big problem with economists is that they are too academic and don't understand how businesses think.

What Wal-mart is doing is obvious for economists too. That's not the point. The problem is more about the ultimate consequences of policies and how the entire system will behave. You are missing the point here.

By the way, I was also in the corporate sector for many years. You get a lot of experience and skills but there are MANY thing you just don't learn by been in the "real world".

Andrew M writes:

Daveg writes:

Shouldn't the first graph really include a shift to account for the wage subsidy that was artificially pumping up the labor demand?

I don't see why Daveg--and many others, of course--treat government funded healthcare to Walmart employees as a "wage subsidy". After all, the healthcare isn't part of what Walmart gives its employees; it isn't conditional on working for Walmart; it can't be used by Walmart to recruit employees, because Walmart can't take it away from those who don't work from them; every eligible person gets it anyway.

I guess people assume, as an axiom, that Walmart, perhaps like all employers, just ought to pay for its employees healthcare; so if Walmart doesn't, and someone else does, then that someone else has done Walmart's duty for it and Walmart has taken a free ride. But why believe the initial assumption? It isn't obvious. And it isn't obvious even if you hold that no one should go without healthcare for lack of money, since holding this doesn't entail that employers, as opposed to, say, neighbors or co-workers should foot the bill.

Actually, if the government paid for my food, lodging, healthcare, and so on, then my present employers would have to raise my salary a great deal to get me to work for them. So it's possible that government healthcare raises the wages that Walmart has to pay to attract its employees.

Randy writes:

daveg,

Re; "...there are laws that explicitly require YOU to pay for the healthcare of others.

Yes, and I don't disagree with many of them. I only see a problem with trying to make free market activities responsible for socio-political concerns. I have no problem whatsoever with the socio-political system solving social problems. They can utilize the wealth created by free market activities in the interests of all. But they have to do this without limiting the ability of the free market activities to create wealth, because the socio-political systems are dependant on that wealth. It isn't helping people who need help that is stupid. Killing the goose that lays the golden eggs - that's stupid.

Tom West writes:

While I understand that conventional economics holds that as price increases demand decreases, I suspect for individual businesses that doesn't hold true. The amount that individuals earn for the company isn't a gradually decreasing function. Instead, external constraints (such as sales) determine the staffing levels. Beyond that point, employees earn no extra income, before that point, reducing employees reduces sales.

Increasing wages may take out the whole business if the extra costs mean the business is no longer viable, but for a successful business like Walmart, they are already using the minimal number of workers that provide extra sales.

I can't see any change in their behaviour.

(It's like a hotel room cleaning business. If you can clean 10 rooms with 1 employee, then if you've got contracts to clean 1000 rooms, if the employee wage rate rises 5% you don't suddenly lay off employees and clean only 800 rooms unless you are no longer making money per hotel room, in which case you go out of business.)

DS writes:

Here's a solution: Walmart should refuse to hire anybody who accepts Medicaid payments. That would make the Maryland legislature happy, right?

I'm pretty sure that will be the outcome here; less employment at Walmart in Maryland. Contrary to the predictions of the anti-Walmart crowd this will NOT result in those people getting higher paying jobs with health benefits at one of Walmart's competitors (or thoe people would already have those jobs). It WILL result in more people recieving welfare payments from the government in Maryland, and higher prices to consumers. But this debate isn't really about welfare payments anyway, so that doesn't really matter.

Just a clarification: aren't the people who accept Medcaid payments from the government getting a "free ride"? Last time I checked Walmart doesn't recieve any Medicaid payments, hence cannot be considered a "free rider". Walmart has no part in the decision to grant Mediacid payments to individuals, nor is it any of their business what their employees do in their personal lives (like accepting medicaid payments). Of course the medicaid issue is a red herring to begin with, so applying logic to that issue is pointless.

The unions have done a brillaint job of creating this verbal slight of hand, and have been aided by a sympathtic main stream media.

James writes:

Tom West,

You write "While I understand that conventional economics holds that as price increases demand decreases, I suspect for individual businesses that doesn't hold true."

If the demand curve for the final good is downward sloping, your conjecture implies that businesses don't attempt to maximize profits.

Steve Sailer writes:

The obvious prediction to make is that more firms will imitate Wal-Mart's highly successful free-riding behavior until more and more of the cost of health care is paid by fewer and fewer people.

Eventually, the political system will respond to this untenable trend with greater government controls, such as the Maryland reforms, or nationalizing health care or at least health care payments.

To say that emergency rooms should instead just turn away sick Wal-Mart employees because they don't have health care is a fantasy. It's not going to happen in America.

Lord writes:

So is Walmart going to cut wages beneath the minimum wage? Not likely. It will add to their costs but unless they charge more, they will eat it.

Boonton writes:

Wait a second, this analysis is really too simplistic.

For example, it has a single wage rate. Doesn't this assume that a $1 spent on employee healthcare is the same as $1 spent on wages? If that is true then the law has no effect on wages or employment. It would be like a law mandating an employer who pays his employees in cash use quarters rather than dollar bills. A pain for the poor guy who has to carry the pay envelopes but essentially a law that would be economically irrelevant.


Second remember the law simply requires 8% of total payroll be spent on healthcare for employees or contributed to the state medicaid program. some interesting features:

1. Employer paid health benefits are tax favored...heavily. $1 spent on wages requires Wal-Mart pay employeer taxes plus employees pay payroll taxes. $1 spent on health insurance frees up tax money on both the employee and employer side.

2. The 8% is accross the board, not for all employees. For example, you could have one worker who has no health coverage (maybe she gets it from her husband who works at a better place) and another who is working just for the healthcare. If the worker with healthcare has 16% going to it then Wal-Mart has achieved the 8% requirement (pretending, of course, that it only has two workers who make the same).

3. This seems to make things really complicated. It would seem that Wal-Mart would rather have employees who opt for the health plan rather than higher wages since this helps it out on taxes. However this means my first observation cannot hold. There cannot be indifference between different mixes of wages vs insurance.

4. In fact, if Wal-Mart could convince more employees to sign up for their healthplans they could even come out ahead. The tax savings might pay for any differential between their actual spending and the 8% requirement. Even more so, more employees means more purchasing power which means it can demand better premiums making its health plans more attractive. One wonders if this could indirectly spark Wal-Mart to seriously apply its expertise at purcashing things on the cheap to tackle exploding health insurance premiums?

5. Another complication is the fact that obviously you cannot model this by assuming employees and employers don't care if their wage comes in the form of health insurance or cash. Clearly there will be some employees who want a heavy health insurance mix and others who want as much cash as they can. Wal-Mart could meet the 8% law by essentially selling lavish plans to those that want it (or offering it to their higher paid, mangement force). Or it could increase participation in its 'bare bones' plans.

6. Naturally the labor supply curve seems rather simplistic here. There's a pool of workers who want healthcare and a pool that wants cash. The reason for this difference is in the US system an employer can buy more healthinsurance with $1 than a worker can do with $1 in after tax wages. Part of this is because of the tax code but a large part is also because of negotiating power the employer often has.

Ian Random writes:

First, if this passes and I worked at a high level position for that store chain. I'd move all cost centers to neighboring states areas to get my employment below the magic threshold and/or outsource everything I could.

I read so many pure propaganda articles that say they cost this state X amount. I don't know if that is the net after they subtract all the new business and job income or not, or just the gross? Also people who work for minimum wage, probably didn't work before or for a similar wage at a different place that was even worse to work for. Do they factor in the savings by not having these people on public assistance? I have no problem with partial public support to help someone grow themselves out of poverty. No one held a gun to these people and said work here. My wife with a bachelor's degree in biology, which is useless for anything other than teaching, is actually looking at minimum wage employment so she can have some pocket money for her computer game addiction and it gets her out of the house. I make enough to cover everything, but having her own job would make her feel better and keep her resume current.

Randy writes:

Boonton,

That's an interesting point that Walmart really could come out ahead in this. But I still think they will fight because its a slippery slope. If the state wins this round, what's to keep it from modifying the rules in the future?

Boonton writes:

First, if this passes and I worked at a high level position for that store chain. I'd move all cost centers to neighboring states areas to get my employment below the magic threshold and/or outsource everything I could.

Then it would be very foolish to hire you to run a store chain. The bill requires 8% of payroll to go against healthcare or the difference to go to the state Medicaid fund. Wal-Mart claims they already spend close to that. So if Wal-Mart spends 6-7% on healthcare are you going to tell me that you're going to close down profitable stores to avoid a 1-2% tax?

That's an interesting point that Walmart really could come out ahead in this. But I still think they will fight because its a slippery slope. If the state wins this round, what's to keep it from modifying the rules in the future?

Well what keeps the state from imposing a 25% requirement? 50%? Even San Francisco balked at the idea of pushing a 'living wage' above $10/hr. As one side pushes the line the resistence by the other side becomes stronger. There's less resistence now probably because many of Wal-Mart's fellow big employers do think Wal-Mart is unfairly dumping its healthcare costs onto the state while they are being 'suckers' and doing the 'right thing' by providing decent insurance for their employees. If the requirement was raised to 15% I'm sure many of those businesses who either support this as a way to get Wal-Mart or just because they think its right will start feeling uneasy and jump ship to join the other side.

Interestingly, Wal-Mart has come out in favor of increasing the min. wage. Their logic is that they already pay a bit above it so it won't hurt them much but on average it will add income in the hands of many of their customers who will use a good chunck of it to buy goods at their stores.

But this is besides the point. The true impact of this law will probably be very difficult to measure since it seems to only make a slight change to the status quo (only 3 companies are big enough to qualify under this law, 2 of them are well above the 8% and Wal-Mart says it is almost there) & it's going to take some potent econometrics to figure out what if anything was done by this law. Since the model presented here, then, is for academic purposes I'm pointing out that it is really way too simplistic to be very useful.

Boonton writes:

What this appears to be is more like a very tiny increase in the minimum wage. What is interesting about that is that there is good empiracle evidence that tiny increases do not have the effect predicted by traditional economics.

In 1992 David Card and Alan B. Krueger looked at an increase in min. wage in NJ to $5.05 an hour while Pennsylvania stayed at $4.25. Since the two areas they looked at were right accross the border from each other they should be economically the same. There should have been in increase in low-wage unemployment in NJ yet the opposite happened. The increase caused some people who were not working to come out and take jobs (an increase in supply, quite predictable by traditional economics) but employers hired them! (In other words a demand increase).

I don't have the mathematics to express what I suspect but I can describe it. Imagine your traditional supply and demand lines but imagine they are not perfectly thin lines like you learned about in geometry. Imagine they are somewhat thick lines. They won't intersect at a point, then, but an area. I suspect equilibrium could be any point inside that area. A small increase in min wage could move that equilibrium provided it stays within that intersection area. If you increase it beyond that you'll get the traditional economics result...unemployment.

Why is it like this? I suspect it comes down to the fact that no one hands you a supply and demand curve when you open a business. Employers have to find a right answer through trial and error. Employers, though, don't need to find a perfect answer. For example, suppose Wal-Mart sets the price of something $0.05 too high. Will the results be horrible? Probably not. In fact, it probably isn't even economically sensible for Wal-Mart to spend a lot of time figuring out which item is $0.05 too high.

Traditional models run the danger of assuming that the players have perfect information know their supply and demand curves. Yet sadly we almost never get to see real life supply and demand curves, at best we only get to see one or two points on them!

Ohhh BTW:

That sounds good, but I would be very surprised if Wal-Mart suddenly told its employees that, due to the new legislation, it was cutting their pay. That would be a sure way to alienate its whole workforce: "Unfair! Unfair!"

Wal-Mart is well known for having a huge turnover in its workforce. If it wanted too, it could cut the money wages for new employees & raise the healthcare wages for older ones and pretty soon it would have effectively cut money wages for the bulk of its workforce.

R.J. Lehmann writes:

The law will never stand up, because it's directly preempted by ERISA. But on the off-chance it does stand up, the effects really won't be all that dramatic, and likely won't involve any change at all to prevailing wage rates. Simply cancelling the group life insurance program -- which was already in the plans, as it is a high-cost, but low priority benefit -- and diverting that money to group health might be enough to push the company over the top. If it isn't, then a combination of a moderate cut to employee discounts and moderate shift toward more full-timers and fewer part-timers (who take longer before they are eligible for benefits) would certainly do the trick.

Malachi writes:

Let's say that the government creates a non-sensical policy such as paying people $0.05 for every soy bean. They just warehouse these soybeans until they go bad, but as we all know governments make bad law sometime. That's what they do.

Not quite a parallel analogy. I haven't read every reply so I hope this hasn't already been mentioned.

More parallel would be that the government decides to subsidize soybeans by paying farmers a nickel for every soybean they produce. This creates a surplus of soybeans. Companies that use soybeans are now only paying a penny per soybean.

The pseudo-philanthropists, otherwise known as legislators, who passed the subsidy bill to begin with, see the largest consumer of soybeans as unfairly gaming the system and pass a bill that they alone have to start paying a nickel per soybean.

What would the effects of that be? The company would have to reduce consumption placing even more demand upon the state, would it not?

It's not a solution. It's just more government to fix a problem created by the government to begin with.

Chris Bolts writes:

You would be correct, Boonton, that this would be a slight increase in the minimum wage rate IF this was an across the board increase for ALL employers. However, the law is not meant to cover government employers at the state and federal levels nor other states.

I don't see this law having too big of an impact on Wal-Mart, nor on any other 10,000+ employer, but I do think it will have an impact on employees. As someone else mentioned, this tax can be deducted from the pay of employees in much the same Social Security and Medicare taxes are.

Comments for this entry have been closed
Return to top