David R. Henderson  

Fringe Benefits and Stagnating Wages

My Ohio Tour... Income and Irresponsibility...

Former co-blogger Arnold Kling has an excellent post this morning on measurement of worker compensation. He quotes a question from one of his readers. I'll let you read it for yourself.

Then Arnold answers:

There is a measure of wage growth that includes the cost of fringe benefits, such as health insurance. This is called compensation per hour. There is also a measure that does not include fringe benefits, which is just called wages. Because health care spending has soared, the "fringe" benefits can amount to quite a lot. Thus, the two measures have diverged, with compensation going up more than wages.

Suppose that my salary is $50,000 a year and the employer contributes $15,000 to my health insurance. The good news for me is that the health insurance benefits are not taxed. The bad news is that I might value the health insurance at much less than $15,000.

Arnold also ends with a beautiful rhetorical flourish:
I should add that if somebody insists on not including fringe benefits in their calculations, you might ask them why then one should consider employer-provided health insurance a good thing.

I want to add two thoughts.

My first thought connects the "good news" and "bad news" parts of Arnold's paragraph above.

Precisely because of the "good news" that health insurance benefits are not taxable to the employee, we can be fairly sure, if employers and employees are optimizing, that employees do value the benefits at much less than the hypothetical $15,000. Why?

It turns out that even though we need to consider the employer's tax situation to compute the optimal spending on health insurance, we don't need to consider it to know how the employee values it. So you can skip the next paragraph if you want.

Consider the employer who, even before required to under ObamaCare, provided health insurance for his employees. The vast majority of employees had such coverage. By providing that insurance, the employer saves himself 7.65%: the 6.2% tax on employee pay for Social Security plus the 1.45% tax for Medicare. (Both of these taxes are deductible against employer income and so the net is more like 5%.)

Now consider the employee. Most employees are in a 25 to 31 percent combined federal, Social Security tax, Medicare tax, and state tax bracket. Why? Most lower income employees are probably in a 15% federal tax bracket, a 7.65% S.S. and Medicare tax bracket, and a 2-3% state tax bracket, for a combined total of about 25%. Most higher-income employees are probably in a 25% federal tax bracket, a 0% S.S. bracket, a 1.45% Medicare bracket and a 4 to 5% state tax bracket, for a combined total of about 31%. Let's use the mid-point of 28%.

The health insurance benefit of $15,000 is worth about $10,800 to employees on average. I computed this by applying the 28% marginal tax rate to the $15,000.

Of course, if it's the optimum (from the employers' and employees' perspective, not from society's perspective, because the tax treatment leads to over-insurance), there will be employees who value it less and employees who value it more.

My second thought is that, as the letter writer to Arnold noted, there are other fringe benefits. One big one, that has grown in the last few decades, is employer contributions to 401(k) and 403(b) pension plans. My employer contributes 5%. That's a big number.

Comments and Sharing

COMMENTS (14 to date)
Andrew_FL writes:

I value the fringe benefits (ie health insurance) at well below their monetary value, since I'm young enough that I'm on my mother's (government employee, and thus quite generous-she's a librarian, works for the county, in case you were wondering) health insurance. I make the same wage as everyone else (well, roughly-it's scaled to your performance to a degree, the point is, I'm not payed more wages because I don't take the benefit) but effectively I'm compensated less because I leave the benefit on the table since I have nothing to gain from it.

I realize this probably isn't a common situation, but still.

David R. Henderson writes:

I realize this probably isn't a common situation, but still.
It’s actually very common for young people, even if they don’t have their parents’ coverage. I had health insurance from the University of Rochester when I was age 24-28, from the Cato Institute when I was age 28-29, and from the University of Santa Clara when I was age 29-31. During all those years, I didn’t file one claim for payment from my insurance company. Comparing notes with other similarly covered young single people, I heard many of the same stories. We all would have preferred more pay and just catastrophic coverage.

Even before ObamaCare, young healthy employees were screwed by the deal their employers gave them; ObamaCare now makes the screwing legally required.

I often wondered, when I was the health economist at the Council of Economic Advisers under Reagan, why employers didn’t treat employees differentially according to age. I asked Joe Newhouse that question and he said “Good question.” Maybe it’s age-discrimination laws. I’m not sure.

Andrew_FL writes:

@David R. Henderson-Well, I meant I figured the specifics of the situation weren't common, and I didn't want to make too much of an anecdote, or seem to be doing so. But yeah, there are lots of other circumstances under which a younger person will lose out due to compensation being concentrated in health benefits rather than wages.

I don't know why they wouldn't do it by age in general but at least in the company I currently work for, there are very few people my age-most of them are significantly older. It probably doesn't make sense for them to draw up different employment contracts for young people if they don't make up a significant portion of their workforce. Too much hassle, I'd guess?

John Goodman writes:

Arnold (or David) should not have left out the employee's share of the FICA tax. Together, the two are avoiding a 15.3% total FICA tax that has to be paid if the employee receives wages rather than health insurance.

So the overall FICA tax avoided is 12.65%

E. Harding writes:

Not really an issue since the early 1990s:
The supplements as a percentage of labor compensation seem to bottom out at business cycle peaks.

David R. Henderson writes:

@John Goodman,
Arnold (or David) should not have left out the employee's share of the FICA tax.
I didn’t leave it out.

BC writes:

Andrew_FL and David Henderson make a great point about the age discrimination in health benefits. Single people also face discrimination because often employers offer spousal and family benefits, but single people do not get cash in lieu of those benefits. (I guess Andrew_FL's mom was actually the beneficiary of that discrimination.)

DH is probably correct that equalizing compensation for young people and single people might run afoul of discrimination laws. For example, it is illegal to ask a job candidate about their marital status even though the compensation for a single person and a married person might be different due to health benefits. Ironically, anti-discrimination laws can compel discrimination.

Bryan R writes:

If the government makes a tax decision on the benefit in question, it should almost certainly be considered income.

If your employer offers a free omelet bar, or reduced prices at the cafeteria, that likely isn't taxed, and shouldn't be considered as part of "income."

But if the government taxes it, or decides not to tax it as a way to motivate behavior, the benefit should certainly be included as income.

To do otherwise is deceitful, in my mind.

Paul writes:

You wrongly assume that the baseline for the employees benefit is the employer's cost.

Because of adverse selection the insurance company would most likely be willing to charge a far lower price to a basically random selection (or at least uncorrelated to health risk) of individuals within a firm than a single individual who wants to buy health insurance. So the firm may be able to purchase a policy on my behalf for $300 per month, which if they gave to me as cash would result in only $216 after-tax. The insurance company may not only be unwilling to insure me at $300 per month, but adverse selection would likely result in rates as high as $800 per month for a comparable policy (see NY's community rating rates pre-ACA "mandates".)

Let's be generous and say I can insure myself for $500 on the individual market. My employer would have to give me $694 before the IRS's cut. But the employer can get me identical coverage for $300 per month. Depending on the demand and supply elasticities we end up with a decline in before-tax wages somewhere between $300 and $694, and both my employer and me are better off. Mutually beneficial trade.

Obviously, employer coverage has an implicit subsidy from young and healthy to old and unhealthy, which BTW creates a precursor to the type of intergenerational imbalance in favor of baby boomers that exists with Medicare and SS.

Daniel Klein writes:

The term fringe benefits isn't as general as non-wage job attributes. For example:

- work demands
- flexibility in schedule
- kindness, amiability in the workplace
- consideration and respect in the workplace
- upward mobility
- unpleasantness/pleasantness of the work
- health insurance
- on-the-job training
- lockers for workers
- food for workers
- air conditioning and good lighting
- workplace safety
- etc. etc. etc.

Non-wage job attributes.

That is the term for all that is beyond the wage.

Tim Worstall writes:

"The health insurance benefit of $15,000 is worth about $10,800 to employees on average. I computed this by applying the 28% marginal tax rate to the $15,000."

Umm, what?

If the employer gives me $15,000 in cash which is taxed then the value to me is $10,800. That's the tax wedge. If the employer gives me $15,000 in cash which is not taxed then the value to me is *more* than $15,000, as I gain the benefit of something like a $20,000 (rough guess) pre-tax income if it were to be taxed.

Yes, sure, the provision of health carte insurance will be, for all sorts of reasons, likely below the value of the equivalent cash (true of almost all benefits in kind). But the existence of the tax wedge itself works the other way doesn't it? By not being taxed that "income" is worth more to the recipient?

David R. Henderson writes:

@Tim Worstall,
If the employer gives me $15,000 in cash which is taxed then the value to me is $10,800. That's the tax wedge. If the employer gives me $15,000 in cash which is not taxed then the value to me is *more* than $15,000, as I gain the benefit of something like a $20,000 (rough guess) pre-tax income if it were to be taxed.
You’re ignoring my statement that employer and employee optimize. If the value of the $15K in health insurance really is well above the equivalent $20K in pay, then the employer is underspending on health insurance. The employer will spend on health insurance up to the point where MB = MC.

Scott Sumner writes:

David, The payroll tax is 15.3%, not 7.65%.

David R. Henderson writes:

@Scott Sumner,
David, The payroll tax is 15.3%, not 7.65%.
I know. I covered that in my post.

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