The Economics of the Affordable Care Act

David Cutler is Otto Eckstein Professor of Applied Economics at Harvard University. He served as senior health care adviser to the Obama presidential campaign in 2008.

Will the Affordable Care Act help or hurt the economy? At a time when economic growth remains mild and the employment outlook is mixed, answering this question is of fundamental importance.

The negative case is easy to understand. The law has a number of provisions that may inhibit employment and growth, including an employer mandate to pay for health insurance coverage (now delayed), increases in the Medicare contribution rate for high-income workers and taxes on medical device companies, health insurance companies and tanning salons. Many economists worry about the economic impact of these provisions (though fewer about the tax on tanning salons).

Casey Mulligan has just presented the gloomy situation on this blog, and he did so well. Professor Mulligan is a serious and concerned analyst; his views are not the rant of those who see death panels lurking around every corner. Indeed, many issues that Professor Mulligan highlights are topics that have drawn public concern; for example, Darden Restaurants (owner of Red Lobster and other chains) drew immense attention - much of it negative - when it announced that it would increase use of part-time labor to avoid the payment requirements for full-time workers under the Affordable Care Act.

Interestingly, the most widely expected adverse effects of the Affordable Care Act have yet to materialize, despite the fact that it has been in place for nearly three years. As a recent chart released by the President’s Council of Economic Advisers shows, hours of work are up in the restaurant industry since March 2010. The same is true in the vast bulk of retail businesses where the option to move workers from full to part time is a real one. It may be that companies are waiting until the employer mandate kicks in - or it could be that the fears of significant adverse effects were overblown.

Additional data from Massachusetts, where a state law was the precursor to the Affordable Care Act, suggests that it is the fears that are overblown. Two studies, one by Jonathan Kolstad and Amanda Kowalski and a second by Lisa Dubay, Sharon Long and Emily Lawton, found very little adverse effect from the employer and individual mandates on employment; workers valued the insurance greatly, so the mandate was actually a benefit for them.

It is possible that the differences between the Massachusetts and federal laws will lead to a different result for the Affordable Care Act, but at this point the evidence overwhelmingly suggests no need for major worry.

The Benefits of Cost Reduction

In looking at the totality of the Affordable Care Act, what is most noticeable for the economy is the good news that it promises for American workers and businesses. The most important component of the act is what it will do to the costs of medical care. For the last 25 years (see Table 5, Page 24, of a study from the National Federation of Independent Business), small businesses have ranked the cost of health insurance as the most critical problem they face. It is no wonder why: rising health insurance costs are associated with increases in total compensation, reduced competitiveness vis-à-vis other companies and increased human-resource problems.

The link between health costs and employment is increasingly clear. A study by Neeraj Sood, Arkadipta Ghosh and José Escarce shows that industries that provided health care to more of their workers in 1986 had significantly lower employment growth between 1987 and 2005. No similar relationship was observed in Canada, where businesses do not pay for health insurance, confirming the role of health care in the relationship. Another study from Katherine Baicker and Amitabh Chandra looks at area-level cost increases in the United States and reaches a similar conclusion.

A fundamental question about the Affordable Care Act is thus what it will do to employer spending on health insurance. The act has a number of provisions designed to reduce spending growth. These include the “Cadillac tax” on expensive health insurance plans and a transition of medical care payments away from fee-for-service payment into value-based payments. Economists are virtually united in asserting that a combination of these demand and supply-side levers are the way to get a handle on a wasteful system.

Already, these payment transitions seem to be having an effect. Health care cost increases are at the lowest level in the last half-century, and employer premium growth has slowed markedly. My own work with Nikhil Sahni shows that the Affordable Care Act is one factor in this slowdown.

In the testimony that Professor Mulligan mentioned and the analytic work behind it (done jointly with Professor Sood), I estimated that slowing cost growth along the lines made possible by the Affordable Care Act would lead to 250,000 to 400,000 jobs gained annually over the next decade. The effects would increase over time.

In the public sector, the impact of a cost slowdown is more difficult to assess. The federal government typically responds to increased Medicare and Medicaid costs by borrowing more. Lower national savings means less investment in plant, equipment and other productive activities. Using standard economic models, the President’s Council of Economic Advisers estimated that slowing medical care cost increases by 1.5 percentage points annually (and effectively borrowing less) would lead to gains in the gross domestic product of 2 percent by 2020 and 8 percent by 2030.

Down the road, higher costs mean either higher taxes or reduced services. Neither the sequester nor the Medicare tax increase in the Affordable Care Act would have been necessary if Washington had dealt with health spending some time back. Similarly, state and local governments have cut education spending, laid off teachers and hired fewer police and fire fighters in response to higher benefit costs. A slowdown in cost growth could bring some of these jobs back.

Professor Mulligan discounts the possibility of implicit tax cuts in the future and does not consider the benefits of any additional spending that may result from lower public-sector health costs; implicitly, his analysis assumes that government spending is all wasteful. I disagree. Making room for productive investment in our economy is one of the major potential benefits of the Affordable Care Act.

Impact on the Work Force

At the work force level, the Affordable Care Act reduces or eliminates many distortions, even as it creates some others. The economist Brigitte Madrian showed nearly two decades ago that many workers were “locked” into their jobs because they had health insurance on a current job and might not be able to maintain that coverage if they switched jobs. Universal insurance coverage would free workers to move to their most productive job or to start a business. Other studies have shown that greater access to health insurance encourages people on disability insurance to work more, reducing the cost for that program.

Then there are the costs of workers missing work (absenteeism) or being less productive at work because they are ill. Common conditions like mental illness, back pain and persistent headaches lead to each of these. Each is treatable but all are undertreated, in part because people are uninsured or underinsured. A recent study pegged the costs of absenteeism and productivity losses on the job at more than $200 billion annually, or about 1.5 percent of G.D.P.

The Affordable Care Act will not eliminate these costs - people will still get sick, after all - but it is likely to reduce them. The recent Oregon Health Study, for example, found that people who gain insurance are much less likely to suffer from depression than their less fortunate peers who remain uninsured.

Are the benefits from reduced job lock, greater work among disability insurance recipients, and less absenteeism and workers ill on the job greater than the potential distortions from shifts into part-time work and increases in marginal tax rates? I do not know; no one has added up the various costs and benefits. For that reason, I did not highlight the work force implications of the Affordable Care Act when I testified before Congress. Instead, I focused on the cost savings implications of the act, which are immense and likely to be more important. I am glad that this forum allows Professor Mulligan and me a chance to discuss these other effects.

What is most clear is that the current health care system is failing families, businesses and governments. The Affordable Care Act is the most serious effort ever made to address the myriad flaws in health care today. If it works as intended, the health of our economy - as well as our people - will be much improved.