E C O N O M I C A N D B U D G E T I S S U E B R I E F 6 CONGRESSIONAL BUDGET OFFICE such as working harder in the hope of winning raises; threshold but creating new disincentives for families accepting new positions or responsibilities with higher whose income was somewhat higher. One study con- compensation; or investing in their future earning capac- cluded that a series of increases in the income limit for ity through education, training, or other means.22 Medicaid eligibility in the late 1980s and 1990s increased the labor force participation of working-age single moth- Policymakers face a trade-off in deciding how to phase out ers by a small but statistically significant amount.24 Creat- subsidies. If subsidies are large and are phased out quickly, ing new subsidies for health insurance for families above the implicit tax rates, and thus the negative impact on the eligibility thresholds for Medicaid would effectively work incentives, can be quite high. Implicit tax rates can reduce the size of current cliffs because people would be reduced by expanding the range over which the subsidy become eligible for the new subsidies at the same time is phased out, but doing so increases the number of they became ineligible for Medicaid. people subject to the implicit tax and boosts the total cost of the subsidy. In the extreme, the same subsidy can be New subsidies might be created to cover the costs of granted to everyone, but doing so substantially increases private health insurance, and they could be gradually budgetary costs, which might in turn be financed through reduced over a specified income range in a variety of higher explicit tax rates. Alternatively, a subsidy can be ways—with different implications for marginal tax rates eliminated all at once at a certain income (creating a and work incentives. Those subsidies could be gradually “cliff” in the relationship of subsidy to income), which reduced at a uniform rate, causing implicit marginal tax eliminates the cost of phasing out the subsidy more grad- rates to rise by the same amount for all recipients in the ually but, for people whose potential income is near the phase-out range. For example, a proposal might provide cliff, significantly increases the disincentives to work families whose income was at the federal poverty level more. People whose income is just below the threshold (roughly $23,000 for a family of four in 2013, the year in can respond by not working more hours, and those whose which many proposals would take effect) with fully subsi- income is just above the threshold may cut their hours of dized health insurance valued at $15,000. That subsidy work in order to qualify for the subsidy. might be gradually reduced as income increased, and families whose income was above 400 percent of the One program that creates work disincentives for its recipi- poverty level ($92,000) might be ineligible for any sub- ents is Medicaid. That program is structured so that eligi- sidy. In that case, marginal tax rates would go up by about bility for benefits is completely eliminated at a specified 22 percentage points for all families whose income was income for most eligibility categories (a cliff).23 For indi- between 100 percent and 400 percent of the poverty level. viduals whose income is close to that threshold, working more and earning a higher income can lead to the loss of An alternative approach would provide subsidies over the Medicaid benefits, creating a disincentive to work more. same income range but would link eligibility for those Proposals that would simply extend Medicaid eligibility to subsidies to an “affordability” standard that would limit families whose income was slightly higher than allowed the amount a family spent on health insurance premiums under current law would effectively move the cliff— to a percentage of family income. For example, a family reducing disincentives to work for families at the current with income at the federal poverty level could be required to pay 1 percent of income but would receive a federal 22. Martin Feldstein, “Effects of Taxes on Economic Behavior,” subsidy for the difference between the cost of their health National Tax Journal, vol. 61, no. 1 (March 2008), pp. 131–139. insurance and the family’s required contribution. That cap on premiums could be set to rise with income—for 23. Although eligibility for Medicaid varies by state, all states are required to cover pregnant women, children under age 6 whose example, increasing to 10 percent of income as the fam- family income is at or below 133 percent of the federal poverty ily’s income rose to 400 percent of the federal poverty level, and children who are at least age 6 but not yet 19 and whose level—and implicit marginal tax rates would also increase family income is up to 100 percent of the federal poverty level. as income rose. An advantage of raising the cap is that Some factors reduce the severity of the cliff: Eligibility for children can extend to higher income levels than eligibility for parents, so families do not lose all their benefits at once; and transitional 24. For estimates of the size of the effect on labor supply, see Aaron S. medical assistance continues Medicaid eligibility temporarily for Yelowitz, “The Medicaid Notch, Labor Supply, and Welfare Par- people whose earnings have risen to a level that would otherwise ticipation: Evidence from Eligibility Expansions,” Quarterly Jour- make them ineligible. nal of Economics, vol. 110, no. 4 (November 1995), pp. 909–939.
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