Bad news for Obamacare opponents: the individual mandate is economically meaningless

John Graham Contributor
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It pains me to write this article, because it will burst a balloon to which many conservatives cling dearly. Nevertheless, it is necessary if we are not only to repeal Obamacare but replace it with reform that puts the American people — not employers or government — in control of our access to medical services.

According to Judge Roger Vinson’s decision on January 31, Congress has no power to legislate an “individual mandate,” whereby the federal government charges the citizen a “penalty” if he does not buy a private health-insurance policy. As an opponent of Obamacare and supporter of the Constitution, it’s a decision I cheer. But as an economist, I find it absurd. If last year’s majority had designed the legislation slightly differently, it would not have prompted the smallest whisper of constitutional challenge.

To be sure, the penalty for disobeying the individual mandate increases government revenues, a legitimate economic reason to oppose Obamacare. However, introducing an individual mandate, per se, changes nothing about the economics of American health care. Furthermore, when we compare a handful of static scenarios, we can easily see that changing the words we use to describe the tax treatment of health benefits cannot have any real impact.

Let’s look at a very simple society comprising two equally productive households: Alice Smith and Barry Jones, under four different scenarios.

Smith earns $50,000 and receives non-taxable employer-based health benefits worth $4,500 for total compensation of $54,500. Jones earns cash wages of $54,500, but receives no health benefits. They pay a 10 percent flat rate of income tax (with no deductions). We don’t know why Jones has forgone health benefits in exchange for more cash wages, but we know that the flexibility of cash is worth at least $450, because that’s how much extra tax he pays as a consequence. The government’s total tax revenue is $10,450. Although oversimplified, scenario A is the status quo in U.S. health care, as described in Table 1.

Now, suppose we want to free the individual to make his own choice of health benefits, instead of passively accepting benefits chosen by his employer. In Table 2, the benefit is transformed into a deduction, which the taxpayer can claim if he buys a qualifying health policy. In Table 3, the benefit is transformed into a tax credit.

In this simple, static analysis, all parties should be utterly indifferent to how the government labels the way it gives a tax benefit to the consumption of health care. In each scenario, employers pay exactly the same amount of remuneration. Smith and Jones enjoy the same net compensation, and the government takes the same tax revenue.

All three scenarios described above can be discussed soberly in conservative and libertarian circles. Once we introduce the terms “individual mandate” or “penalty,” however, the discussion immediately erupts into rancor, loathing, and litigation. The “individual mandate” is described in Table 4.

In Table 4, the flat rate of income tax drops to 9.1743 percent. The government gives no special tax break to Smith for his health benefits and also levies a penalty of $450 on Jones because she has not paid for qualifying health benefits. All parties — Smith, Jones, their employers, and the government — should remain utterly indifferent to which scenario is adopted and enforced by the IRS. This remains true for any tax rate and for any change in income for either Smith or Jones. Try it yourself by downloading the spreadsheet. However, all parties are not indifferent to these four scenarios.

Indeed, Table 1 is enshrined as sacrosanct employer-based health benefits that Congress touches at its peril; Table 2 and Table 3 are interesting scholarly proposals that get little traction in the Beltway, and Table 4 violates the U.S. Constitution! On the other hand, these tables also show that Mitt Romney errs in claiming that the individual mandate satisfies an uninsured citizen’s personal responsibility to pay his medical bills. There is nothing that prevents Congress from specifically allocating Jones’ “extra” $450 payment to fund uncompensated care in any of these four scenarios.

More important, once we move beyond the static analysis in the tables, and examine the dynamics of people’s actual behavior, we see that the real difference is whether the government gives us a tax break to buy health insurance of our own choice, or limits us to health benefits chosen by our employers or — even worse — the government (in an Obamacare health benefits exchange). But that is not the issue at hand in the lawsuits that question the constitutionality of Obamacare.

Don’t get me wrong. I’m thrilled that Judge Vinson found the individual mandate unconstitutional, because real health reform cannot happen until Obamacare is defeated. But let’s not forget that the president’s faction could have achieved the federal takeover without it. And they will surely try another approach if Judge Vinson’s ruling is upheld.

John R. Graham is director of Health Care Studies at the Pacific Research Institute..