Compensating Differentials Chapter 13

2 Labor Economics Workers get paid what they are worth Workers get paid what they are worth Their marginal revenue product Their marginal revenue product Payment can take many forms Payment can take many forms

3 Why Employer-Sponsored Health Insurance? Workers value the coverage Workers value the coverage Cheaper for the employer to buy than for the worker to buy it herself Cheaper for the employer to buy than for the worker to buy it herself Tax treatment Tax treatment Favorable selection Favorable selection Administrative cost savings Administrative cost savings

4 Policy Implications —Compensating Differentials— Mandating Employer Coverage Mandating Employer Coverage Changing Income Tax Rates Changing Income Tax Rates Forcing Workers into Managed Care Forcing Workers into Managed Care Requiring Mental Health Coverage Requiring Mental Health Coverage

5 General Theory —Compensating Differentials— Wage = f(Health Insurance, Other Benefits, Other Benefits, Worker Characteristics, Worker Characteristics, Firm Characteristics) Firm Characteristics)

6 Literature Review —Compensating Differentials— Bulk of studies Bulk of studies Wages higher in the presence of health insurance Wages higher in the presence of health insurance Why? Why? Workers’ Compensation Insurance Workers’ Compensation Insurance Pensions Pensions Health Insurance Health Insurance

7 Workers’ Compensation Insurance Moore and Viscusi (1990) Moore and Viscusi (1990) One dollar increase in workers’ compensation benefits reduced wages by 12 cents per hour One dollar increase in workers’ compensation benefits reduced wages by 12 cents per hour Gruber and Krueger (1991) Gruber and Krueger (1991) 86 percent of workers’ compensation insurance borne by workers in the form of lower wages 86 percent of workers’ compensation insurance borne by workers in the form of lower wages

8 Pensions Life-Cycle Wage Trade-off Life-Cycle Wage Trade-off Montgomery et al. (1990) Montgomery et al. (1990) 80 percent of pension costs paid for by workers in the form of lower wages 80 percent of pension costs paid for by workers in the form of lower wages

9 “Estimating the Compensating Differential for Employer-Provided Health insurance” More productive workers likely to get both more wages and more benefits More productive workers likely to get both more wages and more benefits Wages = f(health benefits, observed worker characteristics, job characteristics) Wages = f(health benefits, observed worker characteristics, job characteristics) But also unobserved worker productivity But also unobserved worker productivity Source: Miller (2004)

10 Methods W = a 0 + a 1 H + a 2 X + a 3 J + a 4 Z + e W = a 0 + a 1 H + a 2 X + a 3 J + a 4 Z + e In each of two time periods In each of two time periods Where H are health benefits, X are worker characteristics, J are job characteristics, and Z are unobserved worker productivity characteristics Where H are health benefits, X are worker characteristics, J are job characteristics, and Z are unobserved worker productivity characteristics ∆W = b 0 + b 1 ∆H + b 2 ∆X + b 3 ∆J + b 4 ∆Z + ε ∆W = b 0 + b 1 ∆H + b 2 ∆X + b 3 ∆J + b 4 ∆Z + ε But ∆Z = 0 But ∆Z = 0 Source: Miller (2004)

11 Data and Findings Consumer Expenditure Survey Consumer Expenditure Survey Bureau of Labor Statistics Bureau of Labor Statistics 1988, 1989, , 1989, 1990 National probability sample National probability sample 3,193 employed people 3,193 employed people Those who lost health insurance coverage over the period got 10 to 11 percent higher wages Those who lost health insurance coverage over the period got 10 to 11 percent higher wages Source: Miller (2004)

12 “The Incidence of Mandated Maternity Benefits” Mandated Maternity Benefits Mandated Maternity Benefits 1975–1979: 23 states mandated maternity benefits 1975–1979: 23 states mandated maternity benefits Examines 3 states that enact the law: Illinois, New Jersey, New York Examines 3 states that enact the law: Illinois, New Jersey, New York 5 control states: Ohio, Idiana, Connecticut, Massachusetts, North Carolina 5 control states: Ohio, Idiana, Connecticut, Massachusetts, North Carolina Source: Gruber (1994b)

13 Methods Basic approach is to compare wages of: Basic approach is to compare wages of: Affected and unaffected groups Affected and unaffected groups In states with and without the law In states with and without the law Before and after enactment Before and after enactment Two approaches: Two approaches: Differences in differences in differences Differences in differences in differences Regression Regression Source: Gruber (1994b)

14 Table 13-1 Estimates of the Effects of Maternity Mandates on Hourly Wages Wages Before Law Wages After Law Time Difference A. Affected Group: Married Women Aged 20 to 40 States with Law$4.70$ % States without Law$3.93$ % Difference-in-Differences-6.2% B. Unaffected Group: People Aged 40 to 60, Single Men Aged 20 to 40 States with Law$5.81$ % States without Law$5.10$ % Difference-in-Differences-0.8% Difference-in-Differences-in- Differences -5.4% Note: percentage changes are correct. Wage values result from taking the antilog of the published values and rounding to the nearest cent. Source: adapted from Gruber (1994b)

15 Conclusions Conclusions: Conclusions: Workers pay for health insurance in the form of lower wages Workers pay for health insurance in the form of lower wages Not only do workers pay, but only those workers who value the coverage pay Not only do workers pay, but only those workers who value the coverage pay Compensating differentials with a vengeance Compensating differentials with a vengeance “The laser beam study” “The laser beam study” Source: Gruber (1994b)

16 “Health Care Costs, Wages, and Aging” Wage = f( relative health costs * age, education, Wage = f( relative health costs * age, education, race, marital status, children, hours, age, region * age) Cost data: Millman and Robertson, Standard benefit package - Standard group of 15 workers Analysis based upon 1989–1990 Current Population Survey data Source: Sheiner (1999)

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18 Table 13-2 Estimated Effects of Higher Health Care Costs on the Age-Wage Profile of Men Continuous Age Cohorts Age * Health Costs- $113 Age 30–34 * Health Costs-$366 Age 35–39 * Health Costs-$562 Age 40–44 * Health Costs-$2,336 Age 45–49 * Health Costs-$2,088 Age 50–54 * Health Costs-$4,664 Age 55–59 * Health Costs-$961 Source: data from Sheiner (1999)

The Reallocation of Compensation in Response to Health Insurance Premium Increases Source: Goldman, Sood, and Leibowitz (2005)

20 Theory How should the compensation bundle change when health insurance premiums increase? How should the compensation bundle change when health insurance premiums increase? Because the price elasticity of health insurance is -1.0, workers who buy coverage will spend more on insurance when premiums increase Because the price elasticity of health insurance is -1.0, workers who buy coverage will spend more on insurance when premiums increase But if labor demand and supply are unchanged, then only the mix of wages, insurance, and other benefits should change; total compensation should not But if labor demand and supply are unchanged, then only the mix of wages, insurance, and other benefits should change; total compensation should not Source: Goldman et al. (2005)

21 Single Employer Study Cafeteria style benefit plan Cafeteria style benefit plan Workers given credit allocation to spend on benefits Workers given credit allocation to spend on benefits Workers may make pretax deductions from wages or salaries to benefits Workers may make pretax deductions from wages or salaries to benefits Workers may “cash out” most of their benefits credit Workers may “cash out” most of their benefits credit Employer makes fixed dollar contribution to any health plan pegged at the price of the catastrophic plan Employer makes fixed dollar contribution to any health plan pegged at the price of the catastrophic plan Source: Goldman et al. (2005)

22 Data Unnamed single large employer Unnamed single large employer 1989, 1990, and 1991 earnings and benefit information 1989, 1990, and 1991 earnings and benefit information Make comparison of changes 1989–1990, 1990–1991 Make comparison of changes 1989–1990, 1990–1991 Workers present in 47 different states Workers present in 47 different states Study restricted to single employees who take health insurance Study restricted to single employees who take health insurance 7,896 employee-years of data 7,896 employee-years of data Source: Goldman et al., (2005)

23 Table 13-3: Details of the Cafeteria Benefits Plan Employee Benefit Options Selected: 1990Compensation:AverageMinMax Health Insurance100%Net Wages$26,504$6,593$109,303 Life Insurance34%Health Insurance$673$0$1,428 Long-Term Disability72%Other Benefits$286$0$5,335 Accident Insurance50%Health Insurance Selected: Dependent Life Ins.1%FFS Catastrophic6.1%8.8%15.0% Retirement6%FFS High Deductible 8.5%10.0%13.6% Health Exp. Account7%FFS Low Deductible 42.6%39.3%34.0% Dental Insurance76%43 HMOs42.8%41.9%37.4% Source: Adapted from Goldman et al. (2005)

24 Table 13-4: Effects of a 10 Percent Increase in Weighted Out-of-Pocket Aggregate Health Insurance Premiums Percent Change Health Insurance Expenditures+5.2% Other Benefits Expenditures-1.5% Wages-3.7% Source: derived from Goldman et al. (2005)

25 Findings $1 increase in health insurance premium led to: $1 increase in health insurance premium led to: 52 cent increase in health insurance expenditures 52 cent increase in health insurance expenditures This increase financed by: This increase financed by: 37 cent reduction in take-home wages 37 cent reduction in take-home wages 15 cent reduction in other benefits 15 cent reduction in other benefits Source: Goldman et al., (2005)

26 Conclusions Results suggest that employees respond to higher premiums by lowering their level of insurance coverage Results suggest that employees respond to higher premiums by lowering their level of insurance coverage But not entirely But not entirely They also absorb some of the increased price by lowering take-home pay and by cutting other benefits They also absorb some of the increased price by lowering take-home pay and by cutting other benefits Results suggest the employers are doing the right thing substituting wage increases for health insurance premium increases Results suggest the employers are doing the right thing substituting wage increases for health insurance premium increases Source: Goldman et al. (2005)

27 Discussion Questions Recalling what you know about moral hazard and compensating differentials, is it conceivable (or likely) that an employer could increase the copays associated with physician visits and prescription drugs, make workers “whole,” and still add something to firm profits as a result? Recalling what you know about moral hazard and compensating differentials, is it conceivable (or likely) that an employer could increase the copays associated with physician visits and prescription drugs, make workers “whole,” and still add something to firm profits as a result?

28 Discussion Questions Some policy advocates have called for the end of the exclusion of employer-sponsored health insurance from income and payroll taxes. If this were to occur, do you anticipate that employers would no longer provide health insurance for their workers? Some policy advocates have called for the end of the exclusion of employer-sponsored health insurance from income and payroll taxes. If this were to occur, do you anticipate that employers would no longer provide health insurance for their workers?

29 Discussion Questions Many businesses, particularly small ones, do not provide health insurance for their workers. Why? Given your answer, would you expect there to be any matching of workers and businesses with respect to the offering of health insurance? Many businesses, particularly small ones, do not provide health insurance for their workers. Why? Given your answer, would you expect there to be any matching of workers and businesses with respect to the offering of health insurance?