Taxes Matter VIII: Will Higher Taxes Put Brake on Health Care Spending?

An intriguing and distressing paper by Jonathan S. Skinner (Dartmouth) and Katherine Baicker (Harvard) titled “Health Care Spending Growth and the Future of U.S. Tax Rates” (NBER Working Paper 16772) finds that growing federal health care costs will drive up future income tax rates to as high as 70 percent.  However, before that nose-bleed level is reached there will be action to stem the growth in health care because the economic damage ($1.48 per dollar of revenue raised) of the higher tax rates will simply be too great to bear.  From the abstract:

Higher Income Tax Rates Due to Higher Health Spending

The fraction of GDP devoted to health care in the United States is the highest in the world and rising rapidly.  Recent economic studies have highlighted the growing value of health improvements, but less attention has been paid to the efficiency costs of tax-financed spending to pay for such improvements.  This paper uses a life cycle model of labor supply, saving, and longevity improvement to measure the balanced-budget impact of continued growth in the Medicare and Medicaid programs.  The model predicts that top marginal tax rates could rise to 70 percent by 2060, depending on the progressivity of future tax changes.  The deadweight loss of the tax system is greater when the financing is more progressive.  If the share of taxes paid by high-income taxpayers remains the same, the efficiency cost of raising the revenue needed to finance the additional health spending is $1.48 per dollar of revenue collected, and GDP declines (relative to trend) by 11 percent.  A proportional payroll tax has a lower efficiency cost (41 cents per dollar of revenue averaged over all tax hikes, a 5 percent drop in GDP) but more than doubles the share of the tax burden borne by lower income taxpayers.  Empirical support for the model comes from analysis of OECD country data showing that countries facing higher tax burdens in 1979 experienced slower health care spending growth in subsequent decades.  The rising burden imposed by the public financing of health care expenditures may therefore serve as a brake on health care spending growth.

Is it me or are they basically saying the world has to blow up before we fix Medicare and Medicaid?  Not exactly the proactive solution . . .

The paper in its most recent form is gated behind NBER’s paywall.  However, I was able to find an earlier version of their paper on NBER’s website dated October 2010: Jonathan S. Skinner (Dartmouth) and Katherine Baicker titled “Health Care Spending Growth and the Future of U.S. Tax Rates” (pdf)

Marginal Income Tax Rates Matter

I can’t ignore this anymore, Barry Ritholtz at Big Picture has been trading fire with Greg Mankiw over his New York Times article I referenced here.  In his latest offensive, Ritholtz has clearly overstated his position with this statement:

The point, which Mankiw so deftly ignored, was that in the real world, people do not respond aggressively to minor incentives (such as marginal changes in income tax).

Really?  Where’s the evidence for such a bold assertion.

First, if behavior does not respond to marginal changes, then economics as we know it does not exist.  Everything is determined at the margin.  Remember the Diamond-Water Paradox that folks struggled with for eons . . . it was solved by the invention of marginal analysis.  Surely, Ritholtz doesn’t mean to overthrow all of economics.

So, secondly, maybe by saying “aggressively” he means folks may change some, but not enough to make a difference.  Well, I’ve been studying migration patterns for some time now.  In two separate states, Connecticut (pdf) and Minnesota (pdf), I have found that out-migration is positively correlated with high state and local tax burdens, especially income taxes (another study in progress finds the same thing)–meaning folks move to where state and local taxes are, on average, lower.  I would consider up-and-moving a pretty “aggressive” tax minimization strategy.  As the saying in Maine goes, “The tax savings from Maine is paying for my house in Florida.”

Finally, don’t just take my word for it.  Harvard economist Martin Feldstein pioneered the empirical estimations of deadweight loss created by “marginal changes in income tax.” In Feldstein’s own words (pdf):

The appropriate size and role of government depend on the deadweight burden caused by incremental transfers of funds from the private sector. The magnitude of that burden depends on the increases in tax rates required to raise incremental revenue and on the deadweight loss that results from higher tax rates … recent econometric work implies that the deadweight burden caused by incremental taxation (the marginal excess burden) may exceed one dollar per one dollar of revenue raised, making the cost of incremental government spending more than two dollars for each dollar of government spending.

I could go on and cite numerous other academic studies that Feldstein and others have done showing significant changes in taxpayer behavior due to changes in the marginal income tax rate.  So, I wonder, who is ignoring reality in this debate?

As for the whole Harvard, Yale, Dartmouth angle . . . Barry Ritholtz fails to distinguish between what Mankiw’s after-tax income would be at each different institution.  It is possible that Mankiw’s professorial talents are high enough that an employer would gladly pay his taxes for him by offering him a higher level of compensation.  If so, then Mankiw would be indifferent to the state that he works in.  My point is . . . just because it could be rational for one person to live in a high tax state, does not mean it is rational for everyone living in the state.