Economic News & Analysis—June 28, 2012
Affordable Care Act: A crisis wasted?By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist, and John Manley, CFA, Chief Equity Strategist
In 2008, when President Obama was then president-elect, his chief of staff, Rahm Emanuel, famously said, “You never want a serious crisis to go to waste.” People on the right excoriated him for taking such a Machiavellian view of politics, but he had a good point. In fact, Franklin Delano Roosevelt used the pain of the Great Depression to transform the U.S. economy, and Ronald Reagan used extremely high unemployment in the 1980s to drive through tax reform in 1981. A crisis can often be a catalyst for significant change.
In my opinion, the Obama administration was working on the wrong crisis at the wrong time and without bipartisan support. Although the U.S. health care system requires fixing, the housing and financial crises were substantially more pressing issues to resolve. Also, any health care solution needs to include the promotion of more competition and efficiency while simultaneously dealing with the problems inherent in a third-party payment system. Under the current system, which has its roots in the wage-control policies implemented during World War II, an employer pays for health insurance coverage of an employee and the insurance company picks up the tab for medical care. Having X pay for Y doesn’t encourage Y to economize on what’s purchased. It’s even worse when you have Z pay Y for what X purchases. Additionally, the fact that the Affordable Care Act (ACA) passed without bipartisan support makes its future questionable.
I believe the ACA has essentially crippled job creation by requiring employers with 50 or more employees to purchase insurance or pay a penalty. When I examined the relationship between payroll growth, employment costs, and productivity, it is as though the ACA increased employment costs by 7.4% even before it fully came into effect. Hiring an employee is an investment, so it’s not just the current cost of hiring someone—training, wages, and benefits—but also the expected future costs of keeping that employee on the payroll that matter.
Chart 1 below shows the net job creation by size of employer from 2000 through the third quarter of 2011. Employers with fewer than 50 employees lost fewer jobs and then gained more net jobs from the first quarter of 2001 to the fourth quarter of 2004. However, employers with fewer than 50 employees have been lagging in job creation since the passage of the ACA on March 23, 2010. This shouldn’t come as a surprise because, under the ACA, the marginal cost of going from 49 to 50 employees is significantly higher than going from 48 to 49. Once that magic number of 50 is reached, an employer is saddled with a whole new set of rules, requirements, and costs, which is one reason I don’t like arbitrary numbers thrown into laws. Is there really a material difference between a firm with 49 employees and one with 50? Drawing such a distinction between these two types of firms seems arbitrary and capricious.
Chart 1: Net job gains or losses by firm size
Market reactionHealth care technology stocks got a boost with the passage of the ACA, perhaps under the assumption that the ACA would encourage hospitals and health care providers to invest more in technology. However, health care provider and biotechnology stocks declined with the passage of the ACA because the law restricts profits for health care providers and perhaps discourages investment in more experimental (and possibly higher payoff) medicines.
This whole situation is a prime example of how market prices move based on shifting expectations. A version of the ACA passed the House of Representatives on October 8, 2009, and the Senate’s version passed on December 24, 2009. By the time the president signed the act into law on March 23, 2010, most of the market price moves were taken into account before the passage of the law, but there was some reaction afterward, especially as people began reading the law to find out what was in it. Before the Supreme Court heard testimony on the constitutionality of the law between March 26, 2012, and March 28, 2012, market prices began reflecting the changing views as to whether the law would be implemented.
Chart 2: Analyst expectations of long-term earnings per share growth rates
Indeed, markets are not omniscient, but when the consensus calls for a certain outcome, and that outcome happens, there is little room for prices to change as a result. It’s really only when the market consensus is one thing and events turn out to be very different that you get “news” and price movements.
The heart of the matterThe crux of the Supreme Court decision today has nothing to do with the economic logic or efficiency behind the ACA but is instead about whether the ACA is constitutional. Does Congress have the power to require individuals to purchase “minimal essential health insurance coverage” or pay a penalty? The Supreme Court said, “Yes.” The penalty, despite how it was originally presented to the American people, amounts to a tax. The government has the authority to tax, so it can require people to buy health insurance coverage or pay the penalty, which is actually a tax.
Now that the ACA is deemed constitutional, that doesn’t mean the arguments are over. Republicans are pledging to repeal it. There are also further constitutional challenges coming. Small businesses may not begin to start hiring at a more rapid pace even though this uncertainty has been resolved. It is still an obstacle to job creation. There's an even larger obstacle to job creation, though, and that is the tax wall.