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There is always a temptation for antitrust agencies and plaintiffs to center a case around so-called “hot” documents — typically company documents with a snippet or sound-bites extracted, some times out of context. Some practitioners argue that “[h]ot document can be crucial to the outcome of any antitrust matter.” Although “hot” documents can help catch the interest of the public, a busy judge or an unsophisticated jury, they often can lead to misleading results. But more times than not, antitrust cases are resolved on economics and what John Adams called “hard facts,” not snippets from emails or other corporate documents. Antitrust case books are littered with cases that initially looked promising based on some supposed hot documents, but ultimately failed because the foundations of a sound antitrust case were missing.

As discussed below this is especially true for a recent case brought by the FTC, FTC v. St. Luke’s, currently pending before the Ninth Circuit Court of Appeals, in which the FTC at each pleading stage has consistently relied on “hot” documents to make its case.

The crafting and prosecution of civil antitrust cases by federal regulators is a delicate balancing act. Regulators must adhere to well-defined principles of antitrust enforcement, and on the other hand appeal to the interests of a busy judge. The simple way of doing this is using snippets of documents to attempt to show the defendants knew they were violating the law.

After all, if federal regulators merely had to properly define geographic and relevant product markets, show a coherent model of anticompetitive harm, and demonstrate that any anticipated harm would outweigh any procompetitive benefits, where is the fun in that? The reality is that antitrust cases typically rely on economic analysis, not snippets of hot documents. Antitrust regulators routinely include internal company documents in their cases to supplement the dry mechanical nature of antitrust analysis. However, in isolation, these documents can create competitive concerns when they simply do not exist.

With this in mind, it is vital that antitrust regulators do not build an entire case around what seem to be inflammatory documents. Quotes from executives, internal memoranda about competitors, and customer presentations are the icing on the cake after a proper antitrust analysis. As the International Center for Law and Economics’ Geoff Manne once explained,

[t]he problem is that these documents are easily misunderstood, and thus, while the economic significance of such documents is often quite limited, their persuasive value is quite substantial.

Herein lies the problem illustrated by the Federal Trade Commission’s use of provocative documents in its suit against the vertical acquisition of Saltzer Medical Group, an independent physician group comprised of 41 doctors, by St. Luke’s Health System. The FTC seeks to stop the acquisition involving these two Idaho based health care providers, a $16 million transaction, and a number comparatively small to other health care mergers investigated by the antitrust agencies. The transaction would give St. Luke’s a total of 24 primary care physicians operating in and around Nampa, Idaho.

In St. Luke’s the FTC used “hot” documents in each stage of its pleadings, from its complaint through its merits brief on appeal. Some of the statements pulled from executives’ emails, notes and memoranda seem inflammatory suggesting St. Luke’s intended to increase prices and to control market share all in order to further its strength relative to payer contracting. These statements however have little grounding in the reality of health care competition.

The reliance by the FTC on these so-called hot documents is problematic for several reasons. First, the selective quoting of internal documents paints the intention of the merger solely to increase profit for St. Luke’s at the expense of payers, when the reality is that the merger is premised on the integration of health care services and the move from the traditional fee-for-service model to a patient-centric model. St Luke’s intention of incorporating primary care into its system is in-line with the goals of the Affordable Care Act to promote over all well-being through integration. The District Court in this case recognized that the purpose of the merger was “primarily to improve patient outcomes.” And, in fact, underserved and uninsured patients are already benefitting from the transaction.

Second, the selective quoting suggested a narrow geographic market, and therefore an artificially high level of concentration in Nampa, Idaho. The suggestion contradicts reality, that nearly one-third of Nampa residents seek primary care physician services outside of Nampa. The geographic market advanced by the FTC is not a proper market, regardless of whether selected documents appear to support it. Without a properly defined geographic market, it is impossible to determine market share and therefore prove a violation of the Clayton Antitrust Act.

The DOJ Antitrust Division and the FTC have acknowledged that markets can not properly be defined solely on spicy documents. Writing in their 2006 commentary on the Horizontal Merger Guidelines, the agencies noted that

[t]he Agencies are careful, however, not to assume that a ‘market’ identified for business purposes is the same as a relevant market defined in the context of a merger analysis. … It is unremarkable that ‘markets’ in common business usage do not always coincide with ‘markets’ in an antitrust context, inasmuch as the terms are used for different purposes.

Third, even if St. Luke’s had the intention of increasing prices, just because one wants to do something such as raise prices above a competitive level or scale back research and development expenses — even if it genuinely believes it is able — does not mean that it can. Merger analysis is not a question of mens rea (or subjective intent). Rather, the analysis must show that such behavior will be likely as a result of diminished competition. Regulators must not look at evidence of this subjective intent and then conclude that the behavior must be possible and that a merger is therefore likely to substantially lessen competition. This would be the tail wagging the dog. Instead, regulators must first determine whether, as a matter of economic principle, a merger is likely to have a particular effect. Then, once the analytical tests have been run, documents can support these theories. But without sound support for the underlying theories, documents (however condemning) cannot bring the case across the goal line.

Certainly, documents suggesting intent to raise prices should bring an antitrust plaintiff across the goal line? Not so, as Seventh Circuit Judge Frank Easterbrook has explained:

Almost all evidence bearing on “intent” tends to show both greed and desire to succeed and glee at a rival’s predicament. … [B]ut drive to succeed lies at the core of a rivalrous economy. Firms need not like their competitors; they need not cheer them on to success; a desire to extinguish one’s rivals is entirely consistent with, often is the motive behind competition.

As Harvard Law Professor Phil Areeda observed, relying on documents describing intent is inherently risky because

(1) the businessperson often uses a colorful and combative vocabulary far removed from the lawyer’s linguistic niceties, and (2) juries and judges may fail to distinguish a lawful competitive intent from a predatory state of mind. (7 Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law § 1506 (2d ed. 2003).)

So-called “hot” documents may help guide merger analysis, but served up as a main course make a paltry meal. Merger cases rise or fall on hard facts and economics, and next week we will see if the Ninth Circuit recognizes this as both St. Luke’s and the FTC argue their cases.

A century ago Congress enacted the Clayton Act, which prohibits acquisitions that may substantially lessen competition. For years, the antitrust enforcement Agencies looked at only one part of the ledger – the potential for price increases. Agencies didn’t take into account the potential efficiencies in cost savings, better products, services, and innovation. One of the major reforms of the Clinton Administration was to fully incorporate efficiencies in merger analysis, helping to develop sound enforcement standards for the 21st Century.

But the current approach of the Federal Trade Commission (“FTC”), especially in hospital mergers, appears to be taking a major step backwards by failing to fully consider efficiencies and arguing for legal thresholds inconsistent with sound competition policy. The FTC’s approach used primarily in hospital mergers seems uniquely misguided since there is a tremendous need for smart hospital consolidation to help bend the cost curve and improve healthcare delivery.

The FTC’s backwards analysis of efficiencies is juxtaposed in two recent hospital-physician alliances.

As I discussed in my last post, no one would doubt the need for greater integration between hospitals and physicians – the debate during the enactment of the Affordable Care Act (“ACA”) detailed how the current siloed approach to healthcare is the worst of all worlds, leading to escalating costs and inferior care. In FTC v. St. Luke’s Health System, Ltd., the FTC challenged Boise-based St. Luke’s acquisition of a physician practice in neighboring Nampa, Idaho.

In the case, St. Luke’s presented a compelling case for efficiencies.

As noted by the St. Luke’s court, one of the leading factors in rising healthcare costs is the use of the ineffective fee-for-service system. In their attempt to control costs and abandon fee-for-service payment, the merging parties effectively demonstrated to the court that the combined entity would offer a high level of coordinated and patient-centered care. Therefore, along with integrating electronic records and increasing access for under-privileged patients, the merged entity can also successfully manage population health and offer risk-based payment initiatives to all employed physicians. Indeed, the transaction consummated several months ago has already shown significant cost savings and consumer benefits especially for underserved patients. The court recognized

[t]he Acquisition was intended by St. Luke’s and Saltzer primarily to improve patient outcomes. The Court believes that it would have that effect if left intact.

(Appellants’ Reply Brief at 22, FTC v. St. Luke’s Health Sys., No 14-35173 (9th Cir. Sept. 2, 2014).)

But the court gave no weight to the efficiencies primarily because the FTC set forward the wrong legal roadmap.

Under the FTC’s current roadmap for efficiencies, the FTC may prove antitrust harm via predication and presumption while defendants are required to decisively prove countervailing procompetitive efficiencies. Such asymmetric burdens of proof greatly favor the FTC and eliminate a court’s ability to properly analyze the procompetitive nature of efficiencies against the supposed antitrust harm.

Moreover, the FTC basically claims that any efficiencies can only be considered “merger-specific” if the parties are able to demonstrate there are no less anticompetitive means to achieve them. It is not enough that they result directly from the merger.

In the case of St. Luke’s, the court determined the defendants’ efficiencies would “improve the quality of medical care” in Nampa, Idaho, but were not merger-specific. The court relied on the FTC’s experts to find that efficiencies such as “elimination of fee-for-service reimbursement” and the movement “to risk-based reimbursement” were not merger-specific, because other entities had potentially achieved similar efficiencies within different provider “structures.” The FTC and their experts did not indicate the success of these other models nor dispute that St. Luke’s would achieve their stated efficiencies. Instead, the mere possibility of potential, alternative structures was enough to overcome merger efficiencies purposed to “move the focus of health care back to the patient.” (The case is currently on appeal and hopefully the Ninth Circuit can correct the lower court’s error).

In contrast to the St. Luke’s case is the recent FTC advisory letter to the Norman Physician Hospital Organization (“Norman PHO”). The Norman PHO proposed a competitive collaboration serving to integrate care between the Norman Physician Association’s 280 physicians and Norman Regional Health System, the largest health system in Norman, Oklahoma. In its analysis of the Norman PHO, the FTC found that the groups could not “quantify… the likely overall efficiency benefits of its proposed program” nor “provide direct evidence of actual efficiencies or competitive effects.” Furthermore, such an arrangement had the potential to “exercise market power.” Nonetheless, the FTC permitted the collaboration. Its decision was instead decided on the basis of Norman PHO’s non-exclusive physician contracting provisions.

It seems difficult if not impossible to reconcile the FTC’s approaches in Boise and Norman. In Norman the FTC relied on only theoretical efficiencies to permit an alliance with significant market power. The FTC was more than willing to accept Norman PHO’s “potential to… generate significant efficiencies.” Such an even-handed approach concerning efficiencies was not applied in analyzing efficiencies in St. Luke’s merger.

The starting point for understanding the FTC’s misguided analysis of efficiencies in St. Luke’s and other merger cases stems from the 2010 Horizontal Merger Guidelines (“Guidelines”).

A recent dissent by FTC Commissioner Joshua Wright outlines the problem – there are asymmetric burdens placed on the plaintiff and defendant. Using the Guidelines, FTC’s merger analysis

embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.

Relying on the structural presumption established in United States v. Philadelphia Nat’l Bank, the FTC need only illustrate that a merger will substantially lessen competition, typically demonstrated through a showing of undue concentration in a relevant market, not actual anticompetitive effects. If this low burden is met, the burden is then shifted to the defendants to rebut the presumption of competitive harm.

As part of their defense, defendants must then prove that any proposed efficiencies are cognizable, meaning “merger-specific,” and have been “verified and do not arise from anticompetitive reductions in output or service.” Furthermore, merging parties must demonstrate “by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved…, how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific.”

As stated in a recent speech by FTC Commissioner Joshua Wright,

the critical lesson of the modern economic approach to mergers is that post-merger changes in pricing incentives and competitive effects are what matter.

The FTC’s merger policy “has long been dominated by a focus on only one side of the ledger—anticompetitive effects.” In other words the defendants must demonstrate efficiencies with certainty, while the government can condemn a merger based on a prediction. This asymmetric enforcement policy favors the FTC while requiring defendants meet stringent, unyielding standards.

As the ICLE amicus brief in St. Luke’s discusses, not satisfied with the asymmetric advantage, the plaintiffs in St. Luke’s attempt to “guild the lily” by claiming that efficiencies can only be considered in cases where there is a presumption of competitive harm, perhaps based solely on “first order” evidence, such as increased market shares. Of course, nothing in the law, Guidelines, or sound competition policy limits the defense in that fashion.

The court should consider efficiencies regardless of the level of economic harm. The question is whether the efficiencies will outweigh that harm. As Geoff recently pointed out:

There is no economic basis for demanding more proof of claimed efficiencies than of claimed anticompetitive harms. And the Guidelines since 1997 were (ostensibly) drafted in part precisely to ensure that efficiencies were appropriately considered by the agencies (and the courts) in their enforcement decisions.

With presumptions that strongly benefit the FTC, it is clear that efficiencies are often overlooked or ignored. From 1997-2007, FTC’s Bureau of Competition staff deliberated on a total of 342 efficiencies claims. Of the 342 efficiency claims, only 29 were accepted by FTC staff whereas 109 were rejected and 204 received “no decision.” The most common concerns among FTC staff were that stated efficiencies were not verifiable or were not merger specific.

Both “concerns” come directly from the Guidelines requiring plaintiffs provide significant and oftentimes impossible foresight and information to overcome evidentiary burdens. As former FTC Chairman Tim Muris observed

too often, the [FTC] found no cognizable efficiencies when anticompetitive effects were determined to be likely and seemed to recognize efficiency only when no adverse effects were predicted.

Thus, in situations in which the FTC believes the dominant issue is market concentration, plaintiffs’ attempts to demonstrate procompetitive reasoning are outright dismissed.

The FTC’s efficiency arguments are also not grounded in legal precedent. Courts have recognized that asymmetric burdens are inconsistent with the intent of the Act. As then D.C. Circuit Judge Clarence Thomas observed,

[i]mposing a heavy burden of production on a defendant would be particularly anomalous where … it is easy to establish a prima facie case.

Courts have recognized that efficiencies can be “speculative” or be “based on a prediction backed by sound business judgment.” And in Sherman Act cases the law places the burden on the plaintiff to demonstrate that there are less restrictive alternatives to a potentially illegal restraint – unlike the requirement applied by the FTC that the defendant prove there are no less restrictive alternatives to a merger to achieve efficiencies.

The FTC and the courts should deem worthy efficiencies wherein there is a reasonable likelihood that procompetitive effects will take place post-merger. Furthermore, the courts should not look at efficiencies inside a vacuum. In healthcare, policies and laws, such as the effects of the ACA, must be taken into account. The ACA promotes coordination among providers and incentivizes entities that can move away from fee-for-service payment. In the past, courts relying on the role of health policy in merger analysis have found that efficiencies leading to integrated medicine and “better medical care” are relevant.

In St. Luke’s the court observed that “the existing law seemed to hinder innovation and resist creative solutions” and that “flexibility and experimentation” are “two virtues that are not emphasized in the antitrust law.” Undoubtedly, the current approach to efficiencies makes it near impossible for providers to demonstrate efficiencies.

As Commissioner Wright has observed, these asymmetric evidentiary burdens

do not make economic sense and are inconsistent with a merger policy designed to promote consumer welfare.

In the context of St. Luke’s and other healthcare provider mergers, appropriate efficiency analysis is a keystone of determining a merger’s total effects. Dismissal of efficiencies on the basis of a rigid, incorrect legal procedural structure is not aligned with current economic thinking or a sound approach to incorporate competition analysis into the drive for healthcare reform. It is time for the FTC to set efficiency analysis in the right direction.

There is a consensus in America that we need to control health care costs and improve the delivery of health care. After a long debate on health care reform and careful scrutiny of health care markets, there seems to be agreement that the unintegrated, “siloed approach” to health care is inefficient, costly, and contrary to the goal of improving care. But some antitrust enforcers — most notably the FTC — are standing in the way.

Enlightened health care providers are responding to this consensus by entering into transactions that will lead to greater clinical and financial integration, facilitating a movement from volume-based to value-based delivery of care. Any many aspects of the Affordable Care Act encourage this path to integration. Yet when the market seeks to address these critical concerns about our health care system, the FTC and some state Attorneys General take positions diametrically opposed to sound national health care policy as adopted by Congress and implemented by the Department of Health and Human Services.

To be sure, not all state antitrust enforcers stand in the way of health care reform. For example, many states including New York, Pennsylvania and Massachusetts, seem to be willing to permit hospital mergers even in concentrated markets with an agreement for continued regulation. At the same time, however, the FTC has been aggressively challenging integration, taking the stance that hospital mergers will raise prices by giving those hospitals greater leverage in negotiations.

The distance between HHS and the FTC in DC is about 6 blocks, but in healthcare policy they seem to be are miles apart.

The FTC’s skepticism about integration is an old story. As I have discussed previously, during the last decade the agency challenged more than 30 physician collaborations even though those cases lacked any evidence that the collaborations led to higher prices. And, when physicians asked for advice on collaborations, it took the Commission on average more than 436 days to respond to those requests (about as long as it took Congress to debate and enact the Affordable Care Act).

The FTC is on a recent winning streak in challenging hospital mergers. But those were primarily simple cases with direct competition between hospitals in the same market with very high levels of concentration. The courts did not struggle long in these cases, because the competitive harm appeared straightforward.

Far more controversial is when a hospital acquires a physician practice. This type of vertical integration seems precisely what the advocates for health care reform are crying out for. The lack of integration between physicians and hospitals is a core to the problems in health care delivery. But the antitrust law is entirely solicitous of these types of vertical mergers. There has not been a vertical merger successfully challenged in the courts since 1980 – the days of reruns of the TV show Dr. Kildare. And even the supposedly pro-enforcement Obama Administration has not gone to court to challenge a vertical merger, and the Obama FTC has not even secured a merger consent under a vertical theory.

The case in which the FTC has decided to “bet the house” is its challenge to St. Luke’s Health System’s acquisition of Saltzer Medical Group in Nampa, Idaho.

St. Luke’s operates the largest hospital in Boise, and Saltzer is the largest physician practice in Nampa, roughly 20-miles away. But rather than recognizing that this was a vertical affiliation designed to integrate care and to promote a transition to a system in which the provider takes the risk of overutilization, the FTC characterized the transaction as purely horizontal – no different from the merger of two hospitals. In that manner, the FTC sought to paint concentration levels it designed to assure victory.

But back to the reasons why integration is essential. It is undisputed that provider integration is the key to improving American health care. Americans pay substantially more than any other industrialized nation for health care services, 17.2 percent of gross domestic product. Furthermore, these higher costs are not associated with better overall care or greater access for patients. As noted during the debate on the Affordable Care Act, the American health care system’s higher costs and lower quality and access are mostly associated with the usage of a fee-for-service system that pays for each individual medical service, and the “siloed approach” to medicine in which providers work autonomously and do not coordinate to improve patient outcomes.

In order to lower health care costs and improve care, many providers have sought to transform health care into a value-based, patient-centered approach. To institute such a health care initiative, medical staff, physicians, and hospitals must clinically integrate and align their financial incentives. Integrated providers utilize financial risk, share electronic records and data, and implement quality measures in order to provide the best patient care.

The most effective means of ensuring full-scale integration is through a tight affiliation, most often achieved through a merger. Unlike contractual arrangements that are costly, time-sensitive, and complicated by an outdated health care regulatory structure, integrated affiliations ensure that entities can effectively combine and promote structural change throughout the newly formed organization.

For nearly five weeks of trial in Boise St. Luke’s and the FTC fought these conflicting visions of integration and health care policy. Ultimately, the court decided the supposed Nampa primary care physician market posited by the FTC would become far more concentrated, and the merger would substantially lessen competition for “Adult Primary Care Services” by raising prices in Nampa. As such, the district court ordered an immediate divestiture.

Rarely, however, has an antitrust court expressed such anguish at its decision. The district court readily “applauded [St. Luke’s] for its efforts to improve the delivery of healthcare.” It acknowledged the positive impact the merger would have on health care within the region. The court further noted that Saltzer had attempted to coordinate with other providers via loose affiliations but had failed to reap any benefits. Due to Saltzer’s lack of integration, Saltzer physicians had limited “the number of Medicaid or uninsured patients they could accept.”

According to the district court, the combination of St. Luke’s and Saltzer would “improve the quality of medical care.” Along with utilizing the same electronic medical records system and giving the Saltzer physicians access to sophisticated quality metrics designed to improve their practices, the parties would improve care by abandoning fee-for-service payment for all employed physicians and institute population health management reimbursing the physicians via risk-based payment initiatives.

As noted by the district court, these stated efficiencies would improve patient outcomes “if left intact.” Along with improving coordination and quality of care, the merger, as noted by an amicus brief submitted by the International Center for Law & Economics and the Medicaid Defense Fund to the Ninth Circuit, has also already expanded access to Medicaid and uninsured patients by ensuring previously constrained Saltzer physicians can offer services to the most needy.

The court ultimately was not persuaded by the demonstrated procompetitive benefits. Instead, the district court relied on the FTC’s misguided arguments and determined that the stated efficiencies were not “merger-specific,” because such efficiencies could potentially be achieved via other organizational structures. The district court did not analyze the potential success of substitute structures in achieving the stated efficiencies; instead, it relied on the mere existence of alternative provider structures. As a result, as ICLE and the Medicaid Defense Fund point out:

By placing the ultimate burden of proving efficiencies on the Appellants and applying a narrow, impractical view of merger specificity, the court has wrongfully denied application of known procompetitive efficiencies. In fact, under the court’s ruling, it will be nearly impossible for merging parties to disprove all alternatives when the burden is on the merging party to oppose untested, theoretical less restrictive structural alternatives.

Notably, the district court’s divestiture order has been stayed by the Ninth Circuit. The appeal on the merits is expected to be heard some time this autumn. Along with reviewing the relevant geographic market and usage of divestiture as a remedy, the Ninth Circuit will also analyze the lower court’s analysis of the merger’s procompetitive efficiencies. For now, the stay order is a limited victory for underserved patients and the merging defendants. While such a ruling is not determinative of the Ninth Circuit’s decision on the merits, it does demonstrate that the merging parties have at least a reasonable possibility of success.

As one might imagine, the Ninth Circuit decision is of great importance to the antitrust and health care reform community. If the district court’s ruling is upheld, it could provide a deterrent to health care providers from further integrating via mergers, a precedent antithetical to the very goals of health care reform. However, if the Ninth Circuit finds the merger does not substantially lessen competition, then precompetitive vertical integration is less likely to be derailed by misapplication of the antitrust laws. The importance and impact of such a decision on American patients cannot be understated.

A study released today by the Heritage Foundation (authored by Christopher M. Pope) succinctly describes the inherently anticompetitive nature of Obamacare, which will tend to inflate prices, not reduce costs:

“The growth of monopoly power among health care providers bears much responsibility for driving up the cost of health care over recent years. By mandating that general hospitals provide uncompensated care, state and federal legislators have given them cause to insist on regulations and discriminatory subsidies to protect them from cheaper competitors. Instead of freeing these markets to allow the provision of care by the most efficient organizations, the Affordable Care Act endorses these anti-competitive arrangements. It extends the premium paid for treatment in general hospitals, employs the purchasing power of the Medicare program to encourage the consolidation of medical practices, and reforms insurance law to eliminate many of the margins for competition between carriers. Institutions sheltered from competition tend to accumulate unnecessary costs over time. In the absence of pro-competitive reforms, higher spending under Obamacare is likely to only further inflate prices faced by those seeking affordable care.”

In short, as the study demonstrates, “[t]he shackling of competition is an essential feature of Obamacare, not a bug.” Accordingly, Obamacare’s enactors (Congress) and implementers (especially HHS) could benefit from a dose of competition advocacy aimed at reforming this welfare-destructive regulatory system. The study highlights particular worthwhile reforms:

“■Refuse to prop up monopoly power. Government regulation and spending should not shield dominant providers from competitors. Monopolies are irresponsive to the needs of patients and payers. They are an unreliable method of subsidizing care that tends to both lower quality and inflate costs.

■Repeal certificate-of-need laws. Legislative constraints on the construction of additional medical capacity should be repealed. Innovative providers should be allowed to expand or establish new facilities that challenge incumbents with lower prices and better quality.

■Subsidize patients, not providers. Public policies should be provider-neutral. Payments should reimburse providers for providing care, period. In particular, publicly funded programs should not operate payment systems designed to keep certain providers in business regardless of the quality, volume, or cost of the treatments they provide. If some individuals are unable to pay for their care, policymakers should subsidize such needy individuals directly.

■Allow patients to shop around. Wherever possible governments and employers should put patients in control of the funds expended on their care, and permit them to keep any savings they obtain from seeking out more efficient providers.

■Repeal Obamacare and its mandates. Forcing individuals to purchase standardized health insurance establishes a captive market, making it easier for providers, insurers, and regulators to degrade services and inflate costs with impunity. Repealing Obamacare and its purchase mandates is essential to creating a market in which suppliers have the flexibility to respond to consumer demands for better value for their money.”

Perhaps the Federal Trade Commission, which has a substantial interest in promoting procompetitive health care policies, might consider holding a workshop exploring the merits of these reform proposals, as part of its ongoing initiatives in the health care area. (Commendably, and consistent with one of the Heritage study’s key recommendations, the FTC already has advocated in favor of the repeal of certificate-of-need laws.)

Government impediments to the efficient provision of health care services in the United States are legion.  While much recent attention has focused on the federal Patient Protection and Affordable Care Act, which by design reduces consumer choice and competition, harmful state law restrictions have long been spotlighted by the U.S. Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ).  For example, research demonstrates that state “certificate of need” (CON) laws, which require prior state regulatory approval of new hospitals and hospital expansions, “create barriers to entry and expansion to the detriment of health care competition and consumers.

Less attention, however, has been focused on relatively new yet insidious state anticompetitive restrictions that have been adopted by three states (North Carolina, South Carolina, and New York), and are being considered by other jurisdictions as well – “certificates of public advantage” (COPAs).  COPAs are state laws that grant federal and state antitrust law immunity to health care providers that enter into approved “cooperative arrangements” that it is claimed will benefit state health care quality.  Like CONs, however, COPAs are likely to undermine, rather than promote, efficient and high quality health care delivery, according to the FTC.

As the FTC has pointed out, federal antitrust law already permits joint activity by health care providers that benefits consumers and is reasonably necessary to create efficiencies.  A framework for assessing such activity is found in joint FTC and DOJ Statements of Antitrust Enforcement in Health Care, supplemented by subsequent agency guidance documents.  Moreover, no antitrust exemption is needed to promote efficient cooperative arrangements, because the antitrust laws already allow procompetitive collaborations among competitors.

While COPA laws are not needed to achieve socially desirable ends, they create strong incentives for unnecessary competitive restrictions among rival health care providers, which spawn serious consumer harm.  As the bipartisan Antitrust Modernization Commission observed, “[t]ypically, antitrust exemptions create economic benefits that flow to small, concentrated interest groups, while the costs of the exemption are widely dispersed, usually passed on to a large population of consumers through higher prices, reduced output, lower quality and reduced innovation.”  In short, one may expect that well-organized rent-seekers generally will be behind industry-specific antitrust exemptions.  This is no less true in health care than in other sectors of the economy.

Legislators should not assume that competitive problems created by COPAs can be cured by active supervision carried out by state officials.  Such supervision is difficult, costly, and prone to error, particularly because the supervised entities will have every incentive to mischaracterize their self-serving actions as welfare-enhancing rather than welfare-reducing.  In effect, state supervision absent antitrust sanction may devolve into a form of ad hoc economic regulation, subject to all the imperfections of regulation, including regulatory capture by special interests.

A real world example of the difficulties in regulating COPA arrangements is outlined in a 2011 state-commissioned economic analysis (2011 Study) of the 1995 COPA agreement (NC-COPA) between the State of North Carolina and Mission Health Systems (MHS).  In 1993 the State of North Carolina enacted a COPA statute, which grants federal and state antitrust immunity to parties that submit their cooperative agreements to active supervision by the State of North Carolina.  In 1995, to forestall a DOJ antitrust investigation into the merger of the only two acute-care hospitals in Asheville, North Carolina, MHS, the parent of the acquiring hospital, sought and was granted a COPA by the State.  (This COPA agreement was the first in North Carolina and the first in the nation.)  MHS subsequently expanded into additional health care ventures in western North Carolina, subject to state regulatory supervision specified in NC-COPA and thus free from antitrust scrutiny.  The 2011 Study identified a number of potentially harmful consequences flowing from this regulatory scheme:  (1) by regulating MHS’s average margin across all services and geographic areas, NC-COPA creates an incentive for MHS to expand into lower-margin markets to raise price in core markets without violating margin cap limitations; (2) NC-COPA’s cost cap offers only limited regulatory protection for consumers and creates undesirable incentives for MHS to increase outpatient prices and volumes; and (3) NC-COPA creates an incentive and opportunity for MHS to evade price or margin regulation in one market by instead imposing price increases in a related, but unregulated, market.  Moreover, the 2011 Study concluded that the NC-COPA was unnecessary to address competitive concerns attributable to the 1995 merger.  The State of North Carolina has not yet responded to recommendations in the Study for amending the NC-COPA to address these ills.  What the Study illustrates is that even assuming the best of intentions by regulators, COPAs raise serious problems of implementation and are likely to have deleterious unanticipated effects.  State governments would be well advised to heed the advice of federal (and state) antitrust enforcers and avoid the temptation to substitute regulation for competitive market forces subject to general antitrust law.

In sum, state legislatures should resist the premise that health care competitors will somehow advance the “public interest” if they are freed from antitrust scrutiny and subjected to COPA regulation.  Efficient joint activity can proceed without such special favor, whose natural effect is to incentivize welfare-reducing anticompetitive conduct – conduct which undermines, rather than promotes, health care quality and the general welfare.

The Religious Freedom Restoration Act (RFRA) subjects government-imposed burdens on religious exercise to strict scrutiny.  In particular, the Act provides that “[g]overnment shall not substantially burden a person’s exercise of religion even if the burden results from a rule of general applicability” unless the government can establish that doing so is the least restrictive means of furthering a “compelling government interest.”

So suppose a for-profit corporation’s stock is owned entirely by evangelical Christians with deeply held religious objections to abortion.  May our federal government force the company to provide abortifacients to its employees?  That’s the central issue in Sebelius v. Hobby Lobby Stores, which the Supreme Court will soon decide.  As is so often the case, resolution of the issue turns on a seemingly mundane matter:  Is a for-profit corporation a “person” for purposes of RFRA?

In an amicus brief filed in the case, a group of forty-four corporate and criminal law professors argued that treating corporations as RFRA persons would contradict basic principles of corporate law.  Specifically, they asserted that corporations are distinct legal entities from their shareholders, who enjoy limited liability behind a corporate veil and cannot infect the corporation with their own personal religious views.  The very nature of a corporation, the scholars argued, precludes shareholders from exercising their religion in corporate form.  Thus, for-profit corporations can’t be “persons” for purposes of RFRA.

In what amounts to an epic takedown of the law professor amici, William & Mary law professors Alan Meese and Nathan Oman have published an article explaining why for-profit corporations are, in fact, RFRA persons.  Their piece in the Harvard Law Review Forum responds methodically to the key points made by the law professor amici and to a few other arguments against granting corporations free exercise rights.

Among the arguments that Meese and Oman ably rebut are:

  • Religious freedom applies only to natural persons.

Corporations are simply instrumentalities by which people act in the world, Meese and Oman observe.  Indeed, they are nothing more than nexuses of contracts, provided in standard form but highly tailorable by those utilizing them.  “When individuals act religiously using corporations they are engaged in religious exercise.  When we regulate corporations, we in fact burden the individuals who use the corporate form to pursue their goals.”

  • Given the essence of a corporation, which separates ownership and control, for-profit corporations can’t exercise religion in accordance with the views of their stockholders.

This claim is simply false.  First, it is possible — pretty easy, in fact — to unite ownership and control in a corporation.  Business planners regularly do so using shareholder agreements, and many states, including Delaware, explicitly allow for shareholder management of close corporations.  Second, scads of for-profit corporations engage in religiously motivated behavior — i.e., religious exercise.  Meese and Oman provide a nice litany of examples (with citations omitted here):

A kosher supermarket owned by Orthodox Jews challenged Massachusetts’ Sunday closing laws in 1960.  For seventy years, the Ukrops Supermarket chain in Virginia closed on Sundays, declined to sell alcohol, and encouraged employees to worship weekly.  A small grocery store in Minneapolis with a Muslim owner prepares halal meat and avoids taking loans that require payment of interest prohibited by Islamic law.  Chick-fil-A, whose mission statement promises to “glorify God,” is closed on Sundays.  A deli that complied with the kosher standards of its Conservative Jewish owners challenged the Orthodox definition of kosher found in New York’s kosher food law, echoing a previous challenge by a different corporation of a similar New Jersey law.  Tyson Foods employs more than 120 chaplains as part of its effort to maintain a “faith-friendly” culture.  New York City is home to many Kosher supermarkets that close two hours before sundown on Friday and do not reopen until Sunday.  A fast-food chain prints citations of biblical verses on its packaging and cups.  A Jewish entrepreneur in Brooklyn runs a gas station and coffee shop that serves only Kosher food.  Hobby Lobby closes on Sundays and plays Christian music in its stores.  The company provides employees with free access to chaplains, spiritual counseling, and religiously themed financial advice.  Moreover, the company does not sell shot glasses, refuses to allow its trucks to “backhaul” beer, and lost $3.3 million after declining to lease an empty building to a liquor store.

As these examples illustrate, the assertion by lower courts that “for-profit, secular corporations cannot engage in religious exercise” is just empirically false.

  • Allowing for-profit corporations to have religious beliefs would create intracorporate conflicts that would reduce the social value of the corporate form of business.

The corporate and criminal law professor amici described a parade of horribles that would occur if corporations were deemed RFRA persons.  They insisted, for example, that RFRA protection would inject religion into a corporation in a way that “could make the raising of capital more challenging, recruitment of employees more difficult, and entrepreneurial energy less likely to flourish.”  In addition, they said, RFRA protection “would invite contentious shareholder meetings, disruptive proxy contests, and expensive litigation regarding whether the corporations should adopt a religion and, if so, which one.”

But actual experience suggests there’s no reason to worry about such speculative harms.  As Meese and Oman observe, we’ve had lots of experience with this sort of thing:  Federal and state laws already allow for-profit corporations to decline to perform or pay for certain medical procedures if they have religious or moral objections.  From the Supreme Court’s 1963 Sherbert decision to its 1990 Smith decision, strict scrutiny applied to governmental infringements on corporations’ religious exercise.  A number of states have enacted their own versions of RFRA, most of which apply to corporations.   Thus, “[f]or over half a century, … there has been no per se bar to free exercise claims by for-profit corporations, and the parade of horribles envisioned by the [law professor amici] has simply not materialized.”  Indeed, “the scholars do not cite a single example of a corporate governance dispute connected to [corporate] decisions [related to religious exercise].”

  • Permitting for-profit corporations to claim protection under RFRA will lead to all sorts of false claims of religious belief in an attempt to evade government regulation.

The law professor amici suggest that affording RFRA protection to for-profit corporations may allow such companies to evade regulatory requirements by manufacturing a religious identity.  They argue that “[c]ompanies suffering a competitive disadvantage [because of a government regulation] will simply claim a ‘Road to Damascus’ conversion.  A company will adopt a board resolution asserting a religious belief inconsistent with whatever regulation they find obnoxious . . . .”

As Meese and Oman explain, however, this problem is not unique to for-profit corporations.  Natural persons may also assert insincere religious claims, and courts may need to assess sincerity to determine if free exercise rights are being violated.  The law professor amici contend that it would be unprecedented for courts to assess whether religious beliefs are asserted in “good faith.”  But the Supreme Court decision the amici cite in support of that proposition, Meese and Oman note, held only that courts lack competence to evaluate the truth of theological assertions or the accuracy of a particular litigant’s interpretation of his faith.  “This task is entirely separate … from the question of whether a litigant’s asserted religious beliefs are sincerely held.  Courts applying RFRA have not infrequently evaluated such sincerity.”

***

In addition to rebutting the foregoing arguments (and several others) against treating for-profit corporations as RFRA persons, Meese and Oman set forth a convincing affirmative argument based on the plain text of the statute and the Dictionary Act.  I’ll let you read that one on your own.

I’ll also point interested readers to Steve Bainbridge’s fantastic work on this issue.  Here is his critique of the corporate and criminal law professors’  amicus brief.  Here is his proposal for using the corporate law doctrine of reverse veil piercing to assess a for-profit corporation’s religious beliefs.

Read it all before SCOTUS rules!

Once again, my constitutional law professor has embarrassed me with his gross misunderstanding of the U.S. Constitution.  First, he insisted that it would be “unprecedented” for the U.S. Supreme Court to overturn a statute enacted by a “democratically elected Congress.”  Seventh-grade Civics students know that’s not right, but Mr. Obama’s misstatement did have its intended effect:  It sent a clear signal that the President and his lackeys would call into question the legitimacy of the Supreme Court should it invalidate the Affordable Care Act (ACA).  Duly warned, Chief Justice Roberts changed his vote in NFIB v. Sebelius to save the Court from whatever institutional damage Mr. Obama would have inflicted.

Now President Obama – who chastised his predecessor for offending the constitutional order and insisted that he, a former constitutional law professor, would never stoop so low – has both violated his oath of office and flouted a key constitutional feature, the separation of powers.  I’m speaking of the President’s “administrative fix” to the ACA.  That “fix” consists of a presidential order not to enforce the Act’s minimum coverage provisions, a move that President Obama says will allow insurance companies to continue offering ACA non-compliant policies to those previously enrolled in them if the companies wish to do so and are able to obtain permission at the state level.

This is, of course, nothing more than a transparent attempt to shift blame for the millions of recently canceled policies.  Having priced their more generous ACA-compliant policies on the assumption that there would be an influx of healthy customers now covered by high-deductible, non-compliant policies, insurance companies would shoot themselves in the foot by accepting Mr. Obama’s generous “offer.”  Moreover, state insurance commissioners, aware of the adverse selection likely to result from this last-minute rule change, are unlikely to give their blessing.  (Indeed, several have balked – including the D.C. insurance commissioner, who was promptly fired.)

But putting aside the fact that the administrative fix won’t work, the main problem with it is that it is blatantly unconstitutional.  The Constitution divides power between the three branches of government.  Article I grants to the Congress “all legislative Powers,” including “Power to lay and collect Taxes.”  Article II then directs the President to “take Care that the laws be faithfully executed.” With his administrative fix, President Obama has essentially said, “I promise not to execute the law Congress passed.”

Moreover, the President went further to say, “I promise not to collect a tax the Congress imposed.”  Remember that the penalty for failure to carry ACA-compliant insurance is, for constitutional purposes, a tax.  That was the central holding of last summer’s Obamacare decision, NFIB v. Sebelius.  When the President assured victims of insurance cancellations that he would turn a blind eye to the law and allow their insurers to continue to offer canceled policies, he also implied that he would order his administration not to collect the taxes owed by those in ACA-noncompliant policies.  Indeed, this matter was clarified in the letter the Department of Health and Human Services sent to state insurance commissioners notifying them of the Obama Administration’s decision not to enforce the law as written.  That letter stated that the Department of the Treasury, which is charged (through the IRS) with collecting the ACA’s penalties/taxes, “concur[red] with the transitional relief afforded in this document.”  That means the IRS, pursuant to the President’s order, is promising not to collect a tax the Congress has imposed.

This, my friends, is a major disruption of the constitutional order.  If the President of the United States may simply decide not to collect taxes imposed by the branch of government that has been given exclusive “Power to lay and collect Taxes,” the whole Constitution is thrown off-kilter.  Any time a president wanted to favor some individuals, firms, or industries, he wouldn’t need to go to Congress for approval.  No, he could just order his IRS not to collect taxes from those folks.  Can’t get Congress to approve subsidies for green technologies?  No worries.  Just order your IRS not to collect taxes from firms in that sector.  Or maybe even order a refundable tax credit.  You think Congress has enacted job-killing regulations on an industry?  Just invoke your enforcement discretion and ignore those rules.  Whew!  This sure makes things easier.

President Obama twice promised, under oath, to “take Care that the Laws be faithfully executed.”  Unfortunately, he also rammed through a terrible law.  Our Constitution now gives him the option to enforce the enacted law and pay the political price, or seek Congress’s assistance to change the law.  On the particular matter at issue here, Congress is willing to help the President out.  On Friday, the House of Representatives voted to amend the law to allow insurance companies to continue to offer ACA non-compliant policies.  Mr. Obama doesn’t like some details of the legislative fix he’s been offered.  Unfortunately for him, though, he’s not a king.  He has to work within the constitutional order.

At least, that’s what I thought I learned in constitutional law.

In yesterday’s hearings on the disastrous launch of the federal health insurance exchanges, contractors insisted that part of the problem was a last-minute specification from the government:  the feds didn’t want people to be able to “window shop” for health insurance until they had created a profile and entered all sorts of personal information.

That’s understandable.  For this massive social experiment to succeed — or, at least, to fail less badly — young, healthy people need to buy health insurance.  Policy prices for those folks, though, are going to be really high because (1) the ACA requires all sorts of costly coverages people used to be able to decline, and (2) the Act’s “community rating” and “guaranteed issue” provisions prevent insurers from charging older and sicker people an actuarily appropriate rate and therefore require their subsidization by the young and healthy.  To prevent the sort of sticker shock that might cause young invincibles to forego purchasing insurance, Obamacare advocates didn’t want them seeing unsubsidized insurance rates.  Determining a person’s subsidy, though, requires submisison of all sorts of personal information.  Thus, the original requirement that website visitors create a profile and provide gobs of information before seeing insurance rates.

Given the website’s glitches and the difficulty of actually creating a working profile, the feds have now reversed course and are permitting window shopping.  An applicant can enter his or her state and county, family size, and age range (<50 or >50) and receive a selection of premium estimates.  To avoid dissuading people from applying for coverage in light of high premiums, the website takes great pains to emphasize that the estimated premiums do not account for the available subsidies to which most people will be entitled.  For example, to get my own quote, I had to answer a handful of questions and click “Next” a few times, and in the process of doing so, the website announced seven times that the estimated prices I was about to see would not include the generous subsdies to which I would probably be entitled.  The Obamacare folks, you see, want us consumers to know what we’re really going to have to pay.

Or do they?

According to the website, I could buy a Coventry Bronze $15 co-pay plan for $218.03 per month (unsubsidized).  An Anthem Blue Cross Blue Shield Direct Access Plan would cost me $213.39 per month (unsubsidized).  When I went to a private exchange and conducted the same inquiry, however, I learned that the price for the former policy would be $278.66 and, for the latter, between $270.17.  So the private exchange tells me the price for my insurance would be 27% percent higher than the amount Healthcare.gov estimates in its window shopping feature.  What gives?

As it turns out, the federal exchange assumes (without admitting it) that anyone under age 49 is 27 years old.  The private website, by contrast, based quotes on my real age (42).  Obviously, the older a person is, the higher the premium will be.  Since the ACA mandates that individuals up to age 26 be allowed to stay on their parents’ insurance policies, the age the federal website assumes is the very youngest age at which most people would be required to buy health insurance or pay a penalty.  In other words, the federal website picks the rosiest assumption in estimating insurance premiums and never once tells users it’s doing so.  It does, however, awkwardly remind them seven times in fewer than seven consecutive screens that their actual premiums will probably be lower than the figure quoted.

Can you imagine if a private firm pulled this sort of stunt?  Elizabeth Warren’s friends at the CFPB would be on it like white on rice!

Look, the website problems are a red herring.  Sure, they’re shockingly severe, and they do illustrate the limits of government to run things effectively, limits the ACA architects resolutely disregarded.  But they’ll get fixed eventually.  The main reason they’re a long-term problem is that they exacerbate the Act’s most fundamental flaw: its tendency to create a death spiral of adverse selection in which older and sicker people, beneficiaries under the ACA, purchase health insurance, while young, healthy folks, losers under the Act, forego it.  Once this happens, insurance premiums will skyrocket, encouraging even more young and healthy people to drop out of the pool of insureds and thereby making things even worse.  The most significant problem stemming from the website “glitches” (my, how that term has been stretched!) is that they have made it so hard to apply for insurance that only those most desperate for it — the old and sick, the ones we least need in the pool of insureds — will go through the rigmarole of signing up.  On this point, see Holman Jenkins and George Will.

But who knows.  Maybe Zeke Emanuel can fix the problem by getting the Red Sox to sell Obamacare to young invincibles.  (I’m not kidding.  That was his plan for avoiding adverse selection.)

Go Cards!

The Wegman’s grocery store chain has long offered health insurance benefits to part-time employees working at least 20 hours per week.  The Affordable Care Act, however, has now driven the company to cut health insurance benefits for part-time workers.  Wegman’s management, it seems, has discovered that employees are better off if they can’t get insurance from their employer and are therefore allowed access to the generous subsidies available under the ACA.

As the Buffalo News explains:

[P]art-time employees may actually benefit from Wegmans’ decision, according to Brian Murphy, a partner at Lawley Benefits Group, an insurance brokerage firm in Buffalo.

“If you have an employee that qualifies for subsidized coverage, they might be better off going with that than a limited part-time benefit,” Murphy said.

That’s because subsidized coverage can have a lower out-of-pocket cost for the insured employee while also providing better benefits than an employer-paid plan.

Under the Affordable Care Act, part-time employees are not eligible for health insurance subsidies if their employer offers insurance.

“It’s a win-win. The employee gets subsidized coverage, and the employer gets to lower costs,” Murphy said.

Once employees get a taste for the ACA’s generous subsidies–which far exceed the implicit tax subsidy in employer-provided health insurance–they’ll be hooked on the statute.  Proponents of the ACA should therefore view this as a win-win-win!  The only losers, I suppose, are we taxpayers who must pay for all these subsidies.  At least we can take comfort in the fact that the statute reduces the deficit.

Has a piece of legislation ever been subject to as much cynicism-inspiring manipulation as the Affordable Care Act?  It was rammed through Congress, on a totally partisan basis, via an unprecedented use of the reconciliation process.  Its passage required blatant vote-buying with such unjust goodies as the Cornhusker Kickback and the Louisiana Purchase.  Its proponents sold it with bald-face lies that nobody with any sense believes (e.g., “It will reduce the deficit.”), and they credit it with successes for which it is obviously not responsible.

Now the Obama Administration has decided to delay a key, but unpopular, provision of the Act—the so-called “Employer Mandate” that fines firms with 50 or more employers if they fail to provide qualifying insurance to employees working at least 30 hours per week—until after the mid-term elections.  Never mind that the Act itself doesn’t permit the Administration to waive these requirements.  This is “Obamacare,” after all, and that means The Big Guy gets to decide how it’s implemented.  He sure as heck doesn’t want it generating a bunch of lay-offs and hours-reductions right before mid-term elections!

Many in the business community are cheering the one-year delay.  It does, after all, hold off a provision that has been causing firms to reduce workers’ hours, thereby raising the  administrative costs of keeping businesses properly staffed.  But this delay is going to cause huge problems for implementation of the ACA and does nothing to address the biggest problem inherent in the Employer Mandate scheme.

IMPLEMENTATION PROBLEMS

The reporting system connected to (and delayed along with) the Employer Mandate is integral to the ACA’s subsidized health exchanges.  As Michael Cannon has explained, it’s hard to see how the exchanges could possibly work without the reporting system:

. . . Obamacare offers tax credits and subsidies to certain workers who don’t receive an offer of acceptable coverage from an employer. The law requires employers to report information to the IRS on their coverage offerings, both to determine whether the employer will be subject to penalties and whether its employees will be eligible for credits and subsidies.

The IRS both delayed the imposition of penalties and “suspend[ed] reporting for 2014.” As the American Enterprise Institute’s Tom Miller observes, without that information on employers’ health benefits offerings, the federal government simply cannot determine who will be eligible for credits and subsidies. Without the credits and subsidies, the “rate shock” that workers experience will be much greater and/or many more workers will qualify for the unaffordability exemption from the individual mandate. Either way, fewer workers will purchase health insurance and premiums will rise further, which could ultimately end in an adverse selection death spiral. The administration can’t exactly solve this problem by offering credits and subsidies to everyone who applies either. Not only would this increase the cost of the law, but it would also lead to a backlash in 2015 when some people have their subsidies revoked.

Now, the IRS hasn’t yet released its “formal guidance” detailing how the Employer Mandate/reporting system delay will operate.  It’s possible that regulators have come up with some way to offer selective subsidies absent the reporting system.  But given ACA proponents’ heretofore lack of concern about the practicability of the health care law, I wouldn’t hold my breath.

IGNORING THE BIG PROBLEM WITH THE MANDATE/SUBSIDY SCHEME

Putting aside the apparent political motivation for and practical difficulties created by the Employer Mandate delay, the main problem with the delay is that it simply ignores the huge problem created by the ACA’s mandate/subsidy scheme.

The Employer Mandate ostensibly aims to increase employer-provided health insurance coverage by encouraging employers to provide such coverage as an element of their employees’ compensation.  If a covered employer fails to do so, it faces a $2,000 annual penalty for each of its employees who purchases insurance on a subsidized exchange.  When implemented along with the rest of the ACA, however, the Employer Mandate is unlikely to enhance health insurance coverage for lower-income employees.  Here’s why:

  • The ACA subsidizes purchases on the insurance exchanges by individuals whose employers do not offer qualifying insurance at an affordable rate.  The subsidies are inversely related to income.  They are quite generous at lower income levels and reduce to zero once income exceeds four times the federal poverty level.
  • The only subsidy for employer-provided insurance, by contrast, is an implicit tax subsidy resulting from the fact that compensation paid in the form of insurance benefits, rather than wages, is tax-free.  The dollar value of that implicit tax subsidy for any individual is the sum of her marginal tax rate and the payroll tax rate, times the price of the policy.  (For most lower-income workers, the effective subsidy will be 22.65% * the policy price. That assumes a 7.65% payroll tax (1.45% Medicare + 6.2% Social Security) and a marginal income tax rate of 15%.)
  • Absent the penalty provision of the Employer Mandate, the best outcome from the worker’s standpoint would be for the employer to provide health insurance only if the effective subsidy from getting the insurance benefit tax-free exceeds the subsidy the worker would receive if she purchased her own insurance on a subsidized exchange.  Because lower income workers (1) are subject to lower tax rates and therefore receive a smaller tax subsidy from employer provided insurance, and (2) are eligible for large subsidies on the insurance exchanges, they would typically be better off if their employers dropped coverage and thereby enabled them to access the subsidized exchanges.
  • The penalty provision of the Employer Mandate alters this calculus.  Because an employer that fails to provide health insurance must pay $2,000 per year for each employee that purchases insurance on an exchange, a covered employer that cut its health insurance would be willing to raise its employee’s salary by only the amount the employer would have paid for the policy (the price it doesn’t have to pay) minus $2,000 (the amount of penalty it now has to pay).  Thus, in the face of the Employer Mandate, an employee would prefer that its employer provide health insurance coverage only if the effective tax subsidy from getting insurance tax-free exceeds the subsidy available to the employee on an exchange less $2,000.
  • Because the subsidies available to lower-income workers on the insurance exchanges far exceed — by way more than $2,000 — the effective tax subsidy from employer provided health insurance, most lower-income workers will prefer that their employers drop insurance coverage, pay them more in cash, and allow them to take advantage of taxpayer-financed subsidies on the insurance exchanges.

An example may help here.  Suppose an employer wishes to provide $40,000 in total compensation to a 40 year-old employee who is the head of a four-person household.  If the employer were to purchase a family policy for the employee (approximate cost $12,000/year), she would pay the employee $28,0000/year in cash.  The employee would pay no payroll or income tax on the component of his compensation provided as health insurance, so he would receive an effective federal subsidy of $2,718 (22.65% * $12,000).  If the employer were to drop health care coverage and thus drive the employee to an exchange, the employer would have to pay $2,000 and would therefore reduce to $38,000 the total amount she would pay the employee.  The employee would then receive all his compensation — all $38,000 — as take-home pay.  On the $12,000 that otherwise would have been paid as benefits, he’d have to pay $2,718 in tax, but he would now be eligible to purchase insurance on his own at a heavily subsidized rate. The ACA would limit his out-of-pocket insurance expense to 4.52% of annual income ($1,718), which means he would receive a whopping $10,282 subsidy on the $12,000 family policy.  This employee is $5,564 better off if his employer drops coverage (costing him $4,718:  $2,718 in foregone tax subsidy plus a penalty-induced compensation reduction of $2,000) and allows him to access the more generous subsidies available on state exchanges (benefiting him by $10,282).

This is the huge problem with the ACA’s Employer Mandate/subsidy scheme:  The scheme as a whole creates incentives to dump lower-income employees on the subsidized exchanges.  The Obama Administration’s politically expedient delay in implementation of the Employer Mandate does nothing to alleviate this difficulty.  But it might help Nancy Pelosi get her old job back.