After publishing my recent post discussing how the proponents of the Affordable Care Act (ACA or “ObamaCare”) were making a distinction without a (significant) difference on the terms “substitution effect” versus “income effect,” I saw that Scott Sumner over at EconLog made a similar point on the way some pundits are using the word “voluntary” in this context. In light of Sumner’s post, and also the discussion at my personal blog, I think there is still a lot of confusion on how we’re supposed to classify the impact of the ACA’s various provisions on work effort.
First let’s quickly review the confusion Sumner uncovered. Health care economist (and major advisor on the ACA) Jonathan Gruber recently did damage control on the CBO report by writing in the LA Times:
But actually the CBO did not project lost jobs at all. Job leaving is not the same as job losing. Many Americans who may eventually leave jobs or reduce their work hours will do so by choice to make themselves and their families better off. Voluntary reductions are not a cost of the healthcare reform law, they are a benefit. . . .
But the likelihood of voluntary reductions in work is not the only issue. The CBO also projects work reduction by individuals who cut back on hours or avoid moving up the job ladder because they don’t want to lose Medicaid eligibility, or because they don’t want to make so much in wages that they would lose tax credits to help pay insurance premiums. Unlike voluntary job leaving, this second kind of work reduction would entail real economic distortions and be a cost, not a benefit.
As Sumner points out, Gruber’s dichotomy above makes no sense: The second category of impacts is just as “voluntary” as the first. So if Gruber sweepingly says that “voluntary” withdrawals of labor are a benefit, not a cost, of the ACA, then even those reductions due to what have been called “substitution effects” should be great too.
Let me offer another example of this confusion. In my post on substitution vs. income effects, I asked the reader to first imagine the government offering $50,000 to any worker so long as he or she agreed never to take a job. In the second scenario, I had the government offering vouchers of $50,000 for housing, food, and car leasing, but with no conditions attached to the earnings of the recipient. Both schemes would cause workers to reduce their labor supplied to the market. I argued that if someone thought the first scheme (which was due to “substitution effects”) was bad policy, then that person should also condemn the second scheme (which was due to “income effects”).
In the comments of this discussion at my personal blog, another economist (at least initially) wasn’t sure he agreed with me, because it seemed the impact of these two schemes was vastly different. He wrote: “[I]n the first case in your example, what seems to me the biggest problem is the mandate to never get a job. If people were to voluntarily reduce their supply of labor hours that’s one thing, but we’re talking about a mandate to reduce their supply of labor hours.”
I quote the above not to pick on the guy–he soon admitted that he might agree with me, after all–but just to zero in on the same problem that Sumner found in Gruber’s analysis. There is a feeling that giving low-income workers means-tested subsidies is harmful because the resulting drop in labor output is “involuntary” or a “mandate.”
But no, that’s not what those words mean. In standard economic analysis, the government is only giving more options to someone when it says, “We will give you this bonus money under such-and-such conditions.” After all, the worst-case scenario is for the possible recipient to reject the offer. For an extreme example, if the government says to people, “We will give you $50,000 a year if you punch yourself in the face every morning,” that actually provides more utility to the people who choose to collect the money; if it didn’t, they would simply refuse to punch themselves in the face, and would be right where they were in the absence of the offer.
It’s true that we could get fancier and bring in paternalistic concerns. For example, if the government offered to pay teenagers to start smoking cigarettes, one might understandably argue that a narrow cost/benefit analysis would leave out some important issues of willpower, habit formation, etc.
Yet that doesn’t seem to be what’s going on, in the standard discussions of the Affordable Care Act. It seems that many people (including Gruber, literally one of the world’s experts on the economic analysis of the ACA) are narrowly focusing on “benefits with strings attached” as being onerous for the workers, whereas “benefits with no strings attached” is pure gain.
This analysis is wrong. That was the whole point of my exaggerated scenarios, where the government first offers workers $50,000 if they agree to not hold a job, versus the second scheme whereby it offers $50,000 in vouchers to people. If you agree the first scheme is bad, then you should think the second scheme is bad too.
Part of the problem here is that very few people (Paul Krugman is a notable exception) have actually walked through the logic of why it is a bad thing for government policy to cause some workers to withdraw their labor from the market. I’ll come back to that in a future post; it’s actually not as obvious as it might seem at first. For now–in closing–I’ll just mention that if people went through that exercise, they would see that the distinctions between “substitution” and “income” effects, or the focus on voluntary versus “involuntary” work reduction, are red herrings.