While I am not a fan of the reform plans being discussed, I do agree that health care reform is needed. Many of these reforms would only be applicable to government provided or subsidized insurance, I fervently believe that individuals and insurance companies or health care providers should be allowed to make whatever kinds of agreements they wish in the private market. That being said, here are ten things I would like to see.
1. Cost effectiveness measures. These limit the treatments you can receive, the medicines you can take, and the doctors you can see. A lot of health care that is currently provided has very little benefit. That's fine if you are using your own money, but not if you are using taxpayer money.
2. Substitutes for doctors. If your goal is to cut costs and increase coverage, then this involves increasing the supply of health care. One way to do this is to expand the use of substitutesw such as nurses, practitioners, and physician assistants. Most of my visits can be handled by these people without ever having to see the doctor.
3. Subsidizing medical education. If you can reduce the cost of becoming a doctor, then you can increase the supply of doctors available. My personal preference involves providing payment for med school in exchange for several years of service, just as a West Point education is free with the requirement that the cadet serves in the military after graduation.
4. Focus on preventative care. If someone has government provided health care, then you can require that they come in for an annual check up and actively monitor their situation. This is especially important if we are talking about prenatal care.
5. Health care with externalities. Similar to preventative care, behavior with negative externalities need to be discouraged and positive externalities need to be promoted. This could include things like promoting vaccinations and providing antismoking or diet services.
6. Tort reform. This could cut costs for all customers, not just those with government provided insurance. There could be an explicit ban on suing or a higher cost for policies that include the right to sue.
7. National markets. The market for individual health insurance is really 50 different markets on a state-by-state basis and each state is pretty much dominated by a single provider. Allowing insurers to compete across state lines could cut costs. This would also eliminate the 50 different sets of rules and mandates that currently exist.
8. Doughnuts. It sounds stupid at first, but it actually makes a lot of economic sense. Most people really just need catastrophic insurance that covers major emergencies. These plans may have deductibles of $10,000 for example. This means that people would have to pay for preventative care themselves, and alot of people would go without annual checkups and other preventative measures. Doughnuts provide coverage for preventative care by paying for the first $500 of expenses and they pay for catastrophic care by paying for anything over $10,000, but they don't pay anything in between (the hole in the doughnut). These are really the judgement calls where it is up to you to decide whether or not it is worth spending your own money for the treatment.
9. Innovative insurance offerings. People should be able to buy Health insurance in the same ways that they can buy Life Insurance. You might buy a term plan that holds premiums steady for the next ten or twenty years. You might also buy a whole plan that covers you until you cancel or die and holds premiums constant or at least limits the rate of premium increases.
10. Portability. I don't mind the fact that most people get insurance through their employer, but insurance should not be job-based. However, an expansion of COBRA that allows people to continue their coverage even after employment is terminated doesn't consider the fact that there is a differential tax treatment and that employer-based coverage tends to be way costlier than necessary, at least for healthy employees.
Saturday, January 30, 2010
Jurassic Health Care
As is true with any plan where nothing can go wrong, something will go wrong. I don't know what, if anything, will be passed in Congress, but I see several potential problems regardless of the final outcome. Here now is my top ten list of future problems.
1. If the reform involves expanding coverage either with private or public insurance, then the reimburesment rates paid to doctors under the new plans need to be set. If rates are so low that the newly insured still don't have access to health care because no doctors are willing to accept them as new patients, then what is the point.
2. If reimbursement rates under the new plans are sufficient to entice doctors to accept them, then Medicare members, which have lower reimbursement rates, or people that already have insurance start getting left out.
3. If Medicare increases their reimbursement rates to ensure that members maintain their access to doctors, then this will cause the cost of health care reform to go way beyond the original estimates. I believe that this is a major concern. If health care reform is passed, it will be based on cost estimates that are way below what they will end up being.
4. Private insurers may also increase their reimbursement rates so that their customers can maintain access. Any hope of "bending the curve" is lost.
5. The government steps in to ensure that all patients have equal access to doctors regardless of the reimbursement rates offered. Private insurers will lower their rates since their is now no advantage to offering to pay more. At this point doctors basically become government employees and their offices are jampacked with patients making it harder for everyone to get an appointment and see the doctor.
6. Doctors revolt by no longer accepting insurance and moving to a cash only basis. This may not be a bad thing in terms of reducing the costs of health care as much of the cost goes to unnecessary procedures that people wouldn't pay for if they were paying their own bills.
7. The number of students training to become doctors starts falling as a future of dealing with government red tape doesn't seem so enticing.
8. Another part of cutting the costs of health care is implementing cost effectiveness measures in order to cut the extent of unnecessary procedures. These measures may include things such as less frequent mammograms, new guidelines on transplants, and reduced end-of-life care. The determination of cost effectiveness would be made by experts, also known as death panels.
9. I'm acually a big fan of cost effectiveness and support death panels, but affected parties will cry foul on these measures and demand that they be alowed to receive any care approved by their doctor. Government will no doubt relent and pay for less efficient treatments causing costs to go way beyond original estimates.
10. If insurance reform involving guaranteed issue, community ratings, and individual mandates passes, then premiums for healthy people would rise dramatically. Granted, premiums on sicker people would fall, but you are robbing Peter to pay Paul. I don't think anyone disagrees that this would happen. Some people believe that that is a fair tradeoff and some people don't.
1. If the reform involves expanding coverage either with private or public insurance, then the reimburesment rates paid to doctors under the new plans need to be set. If rates are so low that the newly insured still don't have access to health care because no doctors are willing to accept them as new patients, then what is the point.
2. If reimbursement rates under the new plans are sufficient to entice doctors to accept them, then Medicare members, which have lower reimbursement rates, or people that already have insurance start getting left out.
3. If Medicare increases their reimbursement rates to ensure that members maintain their access to doctors, then this will cause the cost of health care reform to go way beyond the original estimates. I believe that this is a major concern. If health care reform is passed, it will be based on cost estimates that are way below what they will end up being.
4. Private insurers may also increase their reimbursement rates so that their customers can maintain access. Any hope of "bending the curve" is lost.
5. The government steps in to ensure that all patients have equal access to doctors regardless of the reimbursement rates offered. Private insurers will lower their rates since their is now no advantage to offering to pay more. At this point doctors basically become government employees and their offices are jampacked with patients making it harder for everyone to get an appointment and see the doctor.
6. Doctors revolt by no longer accepting insurance and moving to a cash only basis. This may not be a bad thing in terms of reducing the costs of health care as much of the cost goes to unnecessary procedures that people wouldn't pay for if they were paying their own bills.
7. The number of students training to become doctors starts falling as a future of dealing with government red tape doesn't seem so enticing.
8. Another part of cutting the costs of health care is implementing cost effectiveness measures in order to cut the extent of unnecessary procedures. These measures may include things such as less frequent mammograms, new guidelines on transplants, and reduced end-of-life care. The determination of cost effectiveness would be made by experts, also known as death panels.
9. I'm acually a big fan of cost effectiveness and support death panels, but affected parties will cry foul on these measures and demand that they be alowed to receive any care approved by their doctor. Government will no doubt relent and pay for less efficient treatments causing costs to go way beyond original estimates.
10. If insurance reform involving guaranteed issue, community ratings, and individual mandates passes, then premiums for healthy people would rise dramatically. Granted, premiums on sicker people would fall, but you are robbing Peter to pay Paul. I don't think anyone disagrees that this would happen. Some people believe that that is a fair tradeoff and some people don't.
Monday, October 5, 2009
What is and isn't included in health care costs?
Much has been made about the fact that Americans on average spend far more for health care than citizens of other countries and that we still lag those countries in measures of health care outcomes. But there are a lot of questions about what should and should not be counted as health care. One example is cosmetic surgery. This is not covered by health insurance, but it is included in calculations of health care costs. We are paying doctors for breast implants instead of providing health care. Mental Health care costs are also included, as are dental care and elective procedures such as in vitro fertilization. These items are legitimate costs, but their inclusion skews the picture of how much we spend on health care relative to other countries.
Another cost is long-term care. I do not mean to diminish it's importance, but costs could be dramatically reduced if multi-generational households were the norm as they are in many other countries. If I pay $20,000 a year to put my mom in a nursing home, then it is a health care cost. If I give up $20,000 in possible earnings to take care of my mom, then it is not treated as a health care cost. These two situations should be treated the same in order to properly compare health care costs.
American doctors are also paid a lot more than their foreign counterparts. One reason for this is the time and money doctors must devote to their education. In many other countries, medical training is provided by the government, or at least subsidized to a greater extent. in the US the cost of education is indirectly included in health care costs through the higher payments to doctors. In other coutries, these costs are not included in health care costs because they are costs of education.
It may be true that we spend more on health care, but the numbers don't tell the whole story.
Another cost is long-term care. I do not mean to diminish it's importance, but costs could be dramatically reduced if multi-generational households were the norm as they are in many other countries. If I pay $20,000 a year to put my mom in a nursing home, then it is a health care cost. If I give up $20,000 in possible earnings to take care of my mom, then it is not treated as a health care cost. These two situations should be treated the same in order to properly compare health care costs.
American doctors are also paid a lot more than their foreign counterparts. One reason for this is the time and money doctors must devote to their education. In many other countries, medical training is provided by the government, or at least subsidized to a greater extent. in the US the cost of education is indirectly included in health care costs through the higher payments to doctors. In other coutries, these costs are not included in health care costs because they are costs of education.
It may be true that we spend more on health care, but the numbers don't tell the whole story.
Universal Health Insurance
If we really want universal health insurance then we can easily acheive it. I can personally grant every American health insurance right now. It covers anyone at all, there are no restrictions against pre-existing conditions, it is free, it covers anything the doctor and patient want done, and patients can go to any doctor they want. The key is that the plan reimburses the doctor $1 for each patient he sees during the year. So, now EVERYONE has insurance and the problem is solved.
Obviously not. All the talk about the uninsured and the need for insurance reform misses the point that it is health care and not health insurance that matters. No one dies from a lack of insurance, despite the headlines on a recent report, they die from not receiving medical care. There is a difference between health insurance and health care and people would be wise to understand the difference before making reforms.
If doctors won't treat people covered under the insurance plan then no one receives any health care. The government could FORCE doctors to accept patients, which is already occuring with Medicare reimbursement guidelines and will only increase under proposed reforms. The problem with this is that it will lead to a serious shortage of doctors. We alreay have severe shortages in nurses and general practitioners in part due to the reimbursement schedule.
Besides, it is wrong to FORCE doctors to treat patients. Of course, it is equally wrong to FORCE someone else to pay the doctor to treat patients. In both cases, someone is being forced to work without compensation. In one case the doctor is forced to treat patients, in the other case someone is forced to work for free as his wages go to the government in the form of taxes and ultimately to doctors. If you pay 35% of your income in taxes, then you are being forced to work for free 35% of the time.
A fairer system would involve voluntary exchange and would not have to involve government at all. A non-profit health insurance company could be set up that would accept any and all patients and the health care costs would be funded through tax-deductible contributions. If the American public does indeed care about the uninsured and wants to provide health care to everybody, then this is the way to do it.
Will this work any better than my first insurance plan? Probably not. This whole debate isn't about providing health care, it is about power. It is about making someone else do something that people are not willing to do themselves.
Obviously not. All the talk about the uninsured and the need for insurance reform misses the point that it is health care and not health insurance that matters. No one dies from a lack of insurance, despite the headlines on a recent report, they die from not receiving medical care. There is a difference between health insurance and health care and people would be wise to understand the difference before making reforms.
If doctors won't treat people covered under the insurance plan then no one receives any health care. The government could FORCE doctors to accept patients, which is already occuring with Medicare reimbursement guidelines and will only increase under proposed reforms. The problem with this is that it will lead to a serious shortage of doctors. We alreay have severe shortages in nurses and general practitioners in part due to the reimbursement schedule.
Besides, it is wrong to FORCE doctors to treat patients. Of course, it is equally wrong to FORCE someone else to pay the doctor to treat patients. In both cases, someone is being forced to work without compensation. In one case the doctor is forced to treat patients, in the other case someone is forced to work for free as his wages go to the government in the form of taxes and ultimately to doctors. If you pay 35% of your income in taxes, then you are being forced to work for free 35% of the time.
A fairer system would involve voluntary exchange and would not have to involve government at all. A non-profit health insurance company could be set up that would accept any and all patients and the health care costs would be funded through tax-deductible contributions. If the American public does indeed care about the uninsured and wants to provide health care to everybody, then this is the way to do it.
Will this work any better than my first insurance plan? Probably not. This whole debate isn't about providing health care, it is about power. It is about making someone else do something that people are not willing to do themselves.
Thursday, September 17, 2009
Kinky Health Insurance Reform
In addition to a public plan that covers the basic health care needs of everyone and anyone, Kinky Care also slaps the insurance industry upside the head and directs them back to the risk-sharing purpose of insurance. Although I am opposed to the reforms that turn the insurance industry into a cost-sharing bastard child, the insurance industry is in serious need of reform.
Critics point to insurance companies refusal to cover pre-existing conditions as a problem, but I am fine with the insurance company refusing to insure pre-existing conditions. However, I am opposed to denying legitimate claims in order to cut costs. The denial of claims or cancellation of insurance after a claim is made is referred to as rescission. Rescissions are not necessarily evil because they does have a proper role in combating fraud. If an applicant lies about a pre-existing condition and then makes a claim resulting from that pre-existing condition, then a denial of claim and rescission is proper. Combating fraud helps to hold down the cost of honest customers and the right to rescind a policy is cheaper than requiring a verifiable, complete medical history from each applicant. However, denying a claim due to an honest mistake by the customer should be forbidden. So, how can you tell the difference between an honest mistake and a fraudulent application? First, a rescission can only occur when the claim is related to the error in the paperwork. If you forgot to mention a broken leg when you were a child and make a claim for a heart attack, the insurance company must honor the claim. Second, the rescission must occur within a reasonable amount of time -- I'd choose two years. Even if you have a family history of heart disease that you covered up, if you don't make a claim or if they don't catch you for two years, then you are free and clear. The third issue is intent and this is the hardest to determine. Did the applicant make an honest mistake or was he trying to cover something up? You have a heart attack after 6 months and the insurance company finds out that your estranged father was on medication for high blood pressure. That would be one for the courts or arbitration panel to decide.
An associated reform covers changes in premiums. Even if insurance is not rescinded, premiums could still rise after a customer has a serious illness. The term of an insurance contract and the allowable increases in premiums must be laid out in the initial contract. If you want a ten-year contract with premium increases restricted to 5% per year, then you could get it. A year-to-year contract would also be available with the knowledge that the customer is taking on the risk of premium increases.
Critics point to insurance companies refusal to cover pre-existing conditions as a problem, but I am fine with the insurance company refusing to insure pre-existing conditions. However, I am opposed to denying legitimate claims in order to cut costs. The denial of claims or cancellation of insurance after a claim is made is referred to as rescission. Rescissions are not necessarily evil because they does have a proper role in combating fraud. If an applicant lies about a pre-existing condition and then makes a claim resulting from that pre-existing condition, then a denial of claim and rescission is proper. Combating fraud helps to hold down the cost of honest customers and the right to rescind a policy is cheaper than requiring a verifiable, complete medical history from each applicant. However, denying a claim due to an honest mistake by the customer should be forbidden. So, how can you tell the difference between an honest mistake and a fraudulent application? First, a rescission can only occur when the claim is related to the error in the paperwork. If you forgot to mention a broken leg when you were a child and make a claim for a heart attack, the insurance company must honor the claim. Second, the rescission must occur within a reasonable amount of time -- I'd choose two years. Even if you have a family history of heart disease that you covered up, if you don't make a claim or if they don't catch you for two years, then you are free and clear. The third issue is intent and this is the hardest to determine. Did the applicant make an honest mistake or was he trying to cover something up? You have a heart attack after 6 months and the insurance company finds out that your estranged father was on medication for high blood pressure. That would be one for the courts or arbitration panel to decide.
An associated reform covers changes in premiums. Even if insurance is not rescinded, premiums could still rise after a customer has a serious illness. The term of an insurance contract and the allowable increases in premiums must be laid out in the initial contract. If you want a ten-year contract with premium increases restricted to 5% per year, then you could get it. A year-to-year contract would also be available with the knowledge that the customer is taking on the risk of premium increases.
The final major reform is the allowance of interstate competition and the removal of federal antitrust exemptions. Insurance companies are currently protected from federal antitrust laws under the 1945 McCarran-Ferguson Act. The supposed reasoning for this exemption is that they are regulated under separate state regulations with a prohibition against interstate competition. This results in individual state markets that are dominated by a single insurance company. Rates among states vary widely largely based on regulations that restrict risk-based premiums or require mandates that customers may not want. A twenty-five year old who doesn't want coverage for mental health care would be charged the same as a sixty-year old who wants his Viagra covered under a state mandate. Moves to repeal the antitrust exemption and to allow interstate competition are already underway and will hopefully pass regardless of the final health care reform.
Health Insurance (as opposed to Health Care) Reform
Alot of the venom regarding health care in the US has been directed at the insurance industry. Nancy Pelosi singled them out as the top villain, town-hall protestors are labeled as industry shills, and the primary evidence of the failure of the current system is the number of uninsured people in the US. In fact, the overall health care reform drive is largely a matter of health insurance reform. But health insurance is not health care and was never meant to be. The purpose of insurance is to spread risk among a large number of people. Unfortunately, the insurance industry seems to have moved away from that goal and I want to institute policies that direct the industry back towards their original purpose. Reformers, however, want to turn the insurance industry into something it was never meant to be.
The principle idea behind insurance is that bad things will happen to some people, but not to everyone. If there are ten people and each one of them has a 10% chance of having an accident that will cost $100,000, then each person has an expected cost of $10,000 and the insurance company will charge each person $10,000 (plus some profit) for coverage. If some people choose not to buy insurance, then that won't affect the expected cost of the remaining individuals. The main point is that insurance should charge each person their expected cost plus profit and each person has the right to either buy insurance or not to buy insurance.
Reformers want to turn insurance from risk-sharing to cost-sharing. Under cost sharing, people are no longer charged an amount based on their own level of risk, they are charged an amount based on the collective level of risk. Suppose you had ten people again and one person had a 91% chance of having an accident while the other nine had a 1% chance. Risk-sharing Insurance would charge the nine people $1,000 (plus profit) each and the other person $91,000 (plus profit). Cost-sharing Insurance would still charge each person $10,000. If one of the nine refuses to buy insurance, insurance would have to charge the remaining nine $11,000 each (expected costs are now $99,000 divided by nine people). If another person drops out, the premium would by $12,250 (98,000 divided by 8). The expected costs would be divided among fewer and fewer people until the one person has a premium of $91,000 that he can't afford and the other nine have no insurace.
In order for cost-sharing to work, everyone must be required to buy insurance with the low-risk people effectively subsidizing the costs of the high-risk people. That is why the reformers push three primary reforms: mandates that force everyone to buy insurance (or pay a fine), guaranteed issue which says that insurance companies can't refuse high-risk individuals, and community rating which means that everyone is charged the same regardless of their level of risk. These changes would be accompanied by subsidies that help poor people pay for insurance and taxes that force wealthy people to pay for those subsidies.
The primary healthcare reform proposals being debated result in redistributions from the wealthy to the poor through taxes and subsidies and from low-risk individuals to high-risk individuals (from the healthy to the sick) in the form of individual mandates, community ratings, and guaranteed issue. As far as I'm concerned, there isn't a lick of difference if this is done through a single-payer system, a public option, co-ops, exchanges, or reform of private insurance. I can understand some people supporting this type of reform. It might even be better than what we currently have. But it still isn't the best system and I don't support it.
The fundamental characteristic that a health care policy has to have in order for me to support it is the existence of different levels of quality of care with the customer paying more for higher levels of quality.
The principle idea behind insurance is that bad things will happen to some people, but not to everyone. If there are ten people and each one of them has a 10% chance of having an accident that will cost $100,000, then each person has an expected cost of $10,000 and the insurance company will charge each person $10,000 (plus some profit) for coverage. If some people choose not to buy insurance, then that won't affect the expected cost of the remaining individuals. The main point is that insurance should charge each person their expected cost plus profit and each person has the right to either buy insurance or not to buy insurance.
Reformers want to turn insurance from risk-sharing to cost-sharing. Under cost sharing, people are no longer charged an amount based on their own level of risk, they are charged an amount based on the collective level of risk. Suppose you had ten people again and one person had a 91% chance of having an accident while the other nine had a 1% chance. Risk-sharing Insurance would charge the nine people $1,000 (plus profit) each and the other person $91,000 (plus profit). Cost-sharing Insurance would still charge each person $10,000. If one of the nine refuses to buy insurance, insurance would have to charge the remaining nine $11,000 each (expected costs are now $99,000 divided by nine people). If another person drops out, the premium would by $12,250 (98,000 divided by 8). The expected costs would be divided among fewer and fewer people until the one person has a premium of $91,000 that he can't afford and the other nine have no insurace.
In order for cost-sharing to work, everyone must be required to buy insurance with the low-risk people effectively subsidizing the costs of the high-risk people. That is why the reformers push three primary reforms: mandates that force everyone to buy insurance (or pay a fine), guaranteed issue which says that insurance companies can't refuse high-risk individuals, and community rating which means that everyone is charged the same regardless of their level of risk. These changes would be accompanied by subsidies that help poor people pay for insurance and taxes that force wealthy people to pay for those subsidies.
The primary healthcare reform proposals being debated result in redistributions from the wealthy to the poor through taxes and subsidies and from low-risk individuals to high-risk individuals (from the healthy to the sick) in the form of individual mandates, community ratings, and guaranteed issue. As far as I'm concerned, there isn't a lick of difference if this is done through a single-payer system, a public option, co-ops, exchanges, or reform of private insurance. I can understand some people supporting this type of reform. It might even be better than what we currently have. But it still isn't the best system and I don't support it.
The fundamental characteristic that a health care policy has to have in order for me to support it is the existence of different levels of quality of care with the customer paying more for higher levels of quality.
Wednesday, September 16, 2009
The Laffer Curve
Much has been made about President Obama’s efforts to raise taxes on high income individuals in order to fund additional spending programs such as health care, energy, and the stimulus. Critics cry class warfare and complain that the wealthy shouldn’t be punished in order to provide a welfare state. Defenders say that the rich can afford higher taxes without any big impact on their well-being. The bigger concern to me, and one that isn’t getting the attention that it deserves, is this – it won’t work.
Raising tax rates on high income individuals will not raise as much money as expected and may raise even less money than before. The idea behind this is known as the Laffer Curve and it basically argues that work effort is a declining function of tax rates and that there is some tax rate that maximizes the amount of revenue collected. At low tax rates, people work but the government gets very little tax revenue. As tax rates rise, people will work less so that tax revenues will still rise but at a decreasing rate. At some point, tax revenues will begin to fall as the reduced work effort dominates the higher tax rate. At extremely high tax rates, people won’t work and no money will be collected. If you wish to draw it, the Laffer Curve looks just like an arch.
There is some tax rate that would maximize total taxes, but people disagree on what that rate is. Keynesian economists (Democrats) tend to believe that we are below that point so that higher tax rates lead to higher tax revenues. Meanwhile, supply-side economists (Republicans) tend to believe that we are beyond that point so that raising tax rates actually reduces tax revenues.
In reality, the revenue maximizing tax rate depends on income and you can make a strong argument that high income people should be taxed at lower rates than middle class people. The determining factor is whether or not people have a substitute for working. High income people include business owners, professionals, doctors, lawyers, … and anyone in the highest income levels probably has some control over their career and how much they work. They have the option of taking more vacation, retiring earlier, sheltering income, deferring income, or take some other action that reduces the amount of tax revenue that the government takes in. Any reduction in the amount of work done by these people, and therefore their income, will result in lower tax revenues. Meanwhile, middle class people have less flexibility in their job. Employers expect 40 hours per week with two weeks of vacation – no more, no less. Low income people actually have greater flexibility too in that they can receive state support or work in informal (and untaxed) jobs instead of working in a traditional job.
It is politically infeasible to have lower tax rates on high income people, so the government really needs to determine the tax rate that maximizes tax revenues for this group and then set tax rates for middle and lower income people either equal to or below that rate. So, what rate maximizes tax revenues for high income workers? I honestly don’t know, but I have a feeling we are probably already close to that rate. The highest marginal Federal Tax rates are set to go up to 39% plus state and local income taxes and sales taxes means that we’re probably already at about 50%. I really don’t think that higher rates will lead to higher revenues.
Not everyone agrees with this. Tax rates have been significantly higher than they are today – as high as 91% under Eisenhower – and the economy did just fine. Indeed, there is very little correlation between economic growth and the highest marginal tax rate. There are two reasons for this. First, tax rates should affect the level of income, not the growth rate. When tax rates change, there may be short term effects on growth as people change their work habits, but once these habits are set, there is no reason that the growth rate should be affected. Second, changes in tax rates will only affect a small percentage of tax payers. If you raise tax rates on the highest 2% of workers, then they may cut their effort, but it won’t have a huge impact on the overall economy.
Again, some people disagree and say that the tax cuts just help the rich get richer. As proof of this giveaway they point to the increase in income inequality since the 1950s when tax rates were 91%. In actuality, their argument is self-contradictory and shows the Laffer effect. When tax rates go down on the highest income individuals, they have greater incentives to work and invest which causes their income to go up. Lower tax rates lead to higher before tax incomes. Conversely, higher tax rates lead to lower pre tax incomes. As far as the effect on tax receipts goes, it depends on the strength of that relationship. If an increase in the tax rate from 40% to 50% causes income to fall from $100,000 to $80,000, then tax receipts are unchanged. A smaller impact on income, say a decline to $90,000, would result in higher tax receipts while larger declines in incomes would lead to lower tax receipts. Overall, I think that higher tax rates will do very little to raise revenue, but it might reduce income inequality. This might be a worthwhile objective, but it won’t pay for additional programs.
Raising tax rates on high income individuals will not raise as much money as expected and may raise even less money than before. The idea behind this is known as the Laffer Curve and it basically argues that work effort is a declining function of tax rates and that there is some tax rate that maximizes the amount of revenue collected. At low tax rates, people work but the government gets very little tax revenue. As tax rates rise, people will work less so that tax revenues will still rise but at a decreasing rate. At some point, tax revenues will begin to fall as the reduced work effort dominates the higher tax rate. At extremely high tax rates, people won’t work and no money will be collected. If you wish to draw it, the Laffer Curve looks just like an arch.
There is some tax rate that would maximize total taxes, but people disagree on what that rate is. Keynesian economists (Democrats) tend to believe that we are below that point so that higher tax rates lead to higher tax revenues. Meanwhile, supply-side economists (Republicans) tend to believe that we are beyond that point so that raising tax rates actually reduces tax revenues.
In reality, the revenue maximizing tax rate depends on income and you can make a strong argument that high income people should be taxed at lower rates than middle class people. The determining factor is whether or not people have a substitute for working. High income people include business owners, professionals, doctors, lawyers, … and anyone in the highest income levels probably has some control over their career and how much they work. They have the option of taking more vacation, retiring earlier, sheltering income, deferring income, or take some other action that reduces the amount of tax revenue that the government takes in. Any reduction in the amount of work done by these people, and therefore their income, will result in lower tax revenues. Meanwhile, middle class people have less flexibility in their job. Employers expect 40 hours per week with two weeks of vacation – no more, no less. Low income people actually have greater flexibility too in that they can receive state support or work in informal (and untaxed) jobs instead of working in a traditional job.
It is politically infeasible to have lower tax rates on high income people, so the government really needs to determine the tax rate that maximizes tax revenues for this group and then set tax rates for middle and lower income people either equal to or below that rate. So, what rate maximizes tax revenues for high income workers? I honestly don’t know, but I have a feeling we are probably already close to that rate. The highest marginal Federal Tax rates are set to go up to 39% plus state and local income taxes and sales taxes means that we’re probably already at about 50%. I really don’t think that higher rates will lead to higher revenues.
Not everyone agrees with this. Tax rates have been significantly higher than they are today – as high as 91% under Eisenhower – and the economy did just fine. Indeed, there is very little correlation between economic growth and the highest marginal tax rate. There are two reasons for this. First, tax rates should affect the level of income, not the growth rate. When tax rates change, there may be short term effects on growth as people change their work habits, but once these habits are set, there is no reason that the growth rate should be affected. Second, changes in tax rates will only affect a small percentage of tax payers. If you raise tax rates on the highest 2% of workers, then they may cut their effort, but it won’t have a huge impact on the overall economy.
Again, some people disagree and say that the tax cuts just help the rich get richer. As proof of this giveaway they point to the increase in income inequality since the 1950s when tax rates were 91%. In actuality, their argument is self-contradictory and shows the Laffer effect. When tax rates go down on the highest income individuals, they have greater incentives to work and invest which causes their income to go up. Lower tax rates lead to higher before tax incomes. Conversely, higher tax rates lead to lower pre tax incomes. As far as the effect on tax receipts goes, it depends on the strength of that relationship. If an increase in the tax rate from 40% to 50% causes income to fall from $100,000 to $80,000, then tax receipts are unchanged. A smaller impact on income, say a decline to $90,000, would result in higher tax receipts while larger declines in incomes would lead to lower tax receipts. Overall, I think that higher tax rates will do very little to raise revenue, but it might reduce income inequality. This might be a worthwhile objective, but it won’t pay for additional programs.
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