The High Cost of Low Taxes

One issue in health reform that’s gotten very little attention outside of Greg Mankiw’s blog is that the phase-out of the subsidies for low income people is going to have an impact on their incentives that’s similar to a high marginal tax rate:

According to CBO, a family of four making $54,000 would pay $4,800 for health insurance. The rest of the premium would come from government subsidies. If the family’s income rises to $66,000, the subsidy falls, and the cost of health insurance rises to $7,600. In other words, earning an additional $12,000 requires the family to pay an additional $2,800.

I think the best way to think about this (I sort of doubt Mankiw agrees) is as an illustration of the economic cost borne by U.S. political culture’s extreme aversion to taxation. Americans “know” that high taxes are bad for the economy, but this belief doesn’t really lead them to reject the idea of public responsibility to ensure the provision of certain kinds of services. Instead it often leads politicians to embrace ways of doing things that are much less economically efficient than high taxes would be.

In a socialist dystopia like Sweden, when the decision is made that everyone should have access to a certain level of health care services what happens is that the government pays for everyone to get those services. Compared to a complicated mix of mandates and subsidies, this leads to higher taxes. But it can lead to much less in the way of tax-related economic distortions. What’s more, it makes the tax situation much more transparent to policymakers and analysts. I’m pretty sure that nobody on the Finance Committee intends to create the particular set of weird implicit marginal tax rates that are now going to exist for the near-poor. But a number of the members probably don’t quite see what they’re doing. If they were just straightforwardly sitting down to write a tax law, by contrast, everyone could see what was happening.