Unbiased Analysis of Today's Healthcare Issues

Is the Massachusetts Payroll Tax to Encourage Employer-Provided Health Insurance worth the cost?

Written By: Jason Shafrin - Jan• 23•06

Massachusetts has proposed a health care bill which four major components:

  1. Mandatory insurance for all Massachusetts residents

  2. Firms who do not offer insurance to their employees are subject to a payroll tax of: 5% for firms having between 11 and 100 employees and 7% for firms having over 100 employees. Firms employing 10 employees or less are exempt from this measure.

  3. Repeal of the surcharge employers who provide insurance pay for the “Free Care Pool”, a fund which helps finance health insurance for the poor.

  4. Employers with 50 or fewer employees could purchase insurance through Connector, a Massachusetts health insurance plan for small businesses.

  5. Increase funding for Medicaid and increase reimbursements to physicians and hospitals.

Let’s look at the Pros and Cons…


This bill will certainly increase health coverage. The first reason is of course because health coverage will be mandatory. This will force the uninsured, who are generally younger, into the insurance pool. This will reduce the problem of adverse selection where only the sick want insurance. Old sick people will certainly benefit, but young healthy people may or may not benefit from mandatory insurance.

While the payroll tax at first seems onerous on business, according to a Families USA Report currently only 5% of businesses with 25 or more employees do not offer health insurance and 16.3% of employers with 10-24 employee do not offer insurance. The repeal of the surcharge for the “Free Care Pool” will reduce the cost to firms that provide health insurance for their employees, and after the implementation of the payroll tax, we would expect few firms to not offer group insurance. Connector fund should be of great assistance to help small businesses to reduce their insurance cost. When risks are pooled over many small businesses, insurance costs per employee are lower due to reduced administrative costs and a reduced risk for adverse selection.


Mandatory health insurance may be efficient in the sense that it eliminates adverse selection, however, libertarians would object to the government compelling an individual to purchase thousands of dollars worth of insurance. Does the government know better than you that spending money on food, electricity or your children’s school is less worthwhile then health insurance? Libertarians believe individuals should be able to make that decision for themselves.

In a closed economy, we would expect firms to adopt health insurance to avoid the payroll tax; however firms may also take other actions to avoid the tax. The Massachusetts Taxpayer Foundation perceptively notes that with the increased cost of labor in Massachusetts, many business would set up shop in adjoining states with lower labor costs. In the short run firms would likely simply reduce the cash wages employees earn so that their total compensation (wages + health insurance) is at the same equilibrium amount as before the legislation. If wages were sticky and did not decrease, this could lead to increased unemployment to levels that we see in European countries. Further, firms could substitute capital for labor leading to inefficient production.


Overall, I think this is a good bill, provided that the revenues raised from the payroll tax are used to reduce taxes in other areas. Many of the provisions of the bill address the problems of adverse selection inherent in the health insurance market. Allowing small firms to pool their insurance pools through the Connector fund is a great idea, where no one loses. One question that has not been addressed in any of the reports I saw was ‘how much insurance are employers required to provide in order to be exempt from the payroll tax?’ Forcing employers to provide comprehensive insurance will lead to ‘over-insurance’ for many individuals. On the other hand, allowing employers to only offer ‘catastrophic’ insurance with the option for the purchase of more insurance by employees will give rise to adverse selection again. In the short run, I would expect to see unemployment jump as firms reduce employment since wages are sticky. In the long run, I would expect to see real wages drop slightly in order to compensate for the additional compensation workers receive in the form of health insurance.

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