ACA: Small Businesses Busy with the Health Insurance Exemption

This is a small sliver of analysis considering a single piece of the Affordable Care Act.  If you didn’t know, businesses that employ fewer than 50 full-time employees are exempt from the employer health insurance mandate. That is, employers can go along managing their business as they did before until they employ their 50th full time employee.  At which point, they must provide health insurance to ALL of the full-time employees.

It is simply a marginal increase on the price of labor as a function of quantity of employees.  You might think that because the increased cost of insurance is applied to all employees, then the marginal cost of all of the employees has changed.  But that’s not the case when considering total marginal cost.  Yes, the average cost per employee certainly increases.  But to the employer it increases, by the cost of insurance for each employee, only upon hiring the 50th person.  This must mean that the marginal cost of the 50th employee includes not just his own cost of insurance, but includes the cumulative health insurance cost for ALL employees.

To illustrate, we can imagine a firm which pays $1/h.  When the business employs 49 or fewer people, the marginal cost of an employee is $1/h.  If insurance costs the employer an additional $1/h for each employee, then the 50th employee does not cost $2/h.  It is not merely the cost of his wage plus the cost of his insurance.  It is the cost of his wage, his insurance, and the cost of ALL the other employees’ insurance.  Where the marginal cost of employing the 49th person is $1/h, the marginal cost of employing the 50th person is $51/h ($1 wage + his $1 insurance + $49 of ALL other employee insurances)! Of course, the marginal cost of employing the 51st person only includes his own wage and insurance cost of $2.  But that marginal increase from 49 employees to 50 employees is one heck of a total, marginal, and average cost increase.

More importantly, once you’ve employed your 50th person, the marginal cost per hour of labor for ALL of your employees rises.  It’s easiest to think of this as a lump sum tax levied for every employee [from the perspective of the business].  This post is not at all an exhaustive analysis of the entire law and the ripples throughout the economy.  Specifically, I’m only exploring the effects of the <50 employee exemption.  So what are the immediate implications?

We can start with how the exemption translates in economic terms for the small, <50 business.  First, the mandate has no direct effect on the costs of labor.  Employing people will be as costly as it was before the law.  Fine.  What can we expect to happen as successful and expanding businesses approach a payroll of 50 employees?  Well, it’s not hard to see, that it doesn’t matter why the cost of employees has increased.  The employer pays the higher price of labor regardless of how an employee enjoys his compensation.  There are three routes that business owners will take.

(1) The small business that employs 50 people can reduce other benefits to the employee so that the effective cost of labor remains relatively unchanged.  The employers which do this most effectively will be those that are able to offer compensation that is not commanded by the government.  Maybe the small business will cut the ‘free’ provision of coffee, cafeteria, or bottled water.  Or, maybe the boss can suddenly afford to treat the employees more poorly (Give a pay cut in the form of decency).  Since he’s now paying them more, he’s going to get more out of them – the right to treat employees badly?  What are they going to do? Leave? Not when they’re compensated so handsomely.

The boss is not a jerk for removing the unofficial amenities. He is attempting to keep his costs unchanged in the face of a relative change in the price of compensations.  The composition of the compensation bundle will change as the price and quantity of the different compensations change.  So, as he must pay more of his compensation in the form of health insurance, he will also seek to pay less in other non-health insurance compensations. His ultimate goal is to keep his costs from increasing and at least to keep the cost of total compensation unchanged.  From the point of view of the employee, his total compensation shall remain unchanged if he can be paid in enough health insurance that would offset the reduction of benefits elsewhere in his compensation.  Unless the employee prefers the new compensation package, he is worse off, after the provision of insurance, and receives less value for the work that he performs.

(2) If the business owner can not change the compensation package, then his costs WILL increase.  He will refuse to expand his business further or he may even reduce the size of his business in order to employ fewer than 50 persons.  Or, he may innovate.  As the marginal product of a dollar spent on labor decreases, capital and capital investment become increasingly attractive.  That is, as the business owner makes less profit from each dollar he invests in labor, non-labor sources of profit become more attractive (ATM machines anyone?).  We will see an expanse of labor saving technologies, methodologies, and logistics. This does not bode well for the low skill worker.  As the cost of labor becomes relatively high in contrast to the cost of capital, the least productive persons will find their services no longer needed by such small businesses.

The man on the street might point to such innovation and praise the ACA: “If it were not for the nudging arm of the government, would such labor saving devices have been invented?  Capitalism, on its own, would not have produced the technologies that give us the competitive edge that this country needs!”  But all the time and resources spent by government officials, in designing the guide, and the effort and energy spent by market participants, in complying with the guide, could have been spent on producing goods which would have provided more product/utility/happiness.   After all, while people in the USA spent resources on creating and complying with the higher cost of labor, Chinese firms were busy spending ALL of their resource by producing things that people WANT.

(3)  The final route that the employer health insurance mandate can take is a specific type of innovation.  We will see advances in the technology of organization.  A business that fails to adjust compensation or fails to create labor saving capital will remain the employer of fewer than 50 employees.  The innovation comes in the form of contract.  We will see a profusion of businesses that suddenly employ just shy of 50 people and contract out a higher proportion of the work than they did before.  The small business will increase revenues without increasing the number of employees.  To the small business owner, contract labor offers the product of additional labor without the costs of a 50th employee.  But do not be swooned by the allure of more small businesses. They most often have higher average costs per unit of output.  Translation:  Consumer prices rise.

The employer health insurance mandate increases costs for the small business and increases prices for the consumer.  Businesses that remain small will: (1) decrease the value of compensation to the employee, (2) spend more resources on capital and technology, and (3) spend more resources on costly contractors.  The actual outcome will not be any one of these results.  It will be a mixture of the three, dependent upon the conditions of time and place within the economy.

The 50 employee exemption was created so as to avoid placing an undue burden on the small business owner.  Instead, it has placed another hurdle between the politically powerful ‘big business’ and the little guy.  The average cost per unit of output will increase for small businesses that do not have the benefit of economies of scale which the large businesses enjoy.  It takes capital to get that big.  And it takes an expanding business to afford the capital.  The employer mandate has made it a little closer to impossible for small businesses to succeed as our current big businesses did when they were small.  The <50 exemption has effectively created a preserve for the small business – where anyone can visit them in their ‘natural’ state, unencumbered by the bothers of big business.  How quaint.

The 50 employee rule was created to give the little guy a fighting chance.  Funny how that works.


One thought on “ACA: Small Businesses Busy with the Health Insurance Exemption

  1. Cary says:

    reminds me of the baptists and bootleggers argument. there is almost always good reason to be suspicious. For already mega companies this is costly, but not so much. for the middling firm it can be disastorous, for the smal firm it can be an insurmountable “ceiling” of costs that constantly keep them from becoming the legitimate up and coming challenger to the industry leader…

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