Government-mandated benefits, taxes, and wages.

• Author: Melese, Francois

1. Introduction

   This paper contributes to an ongoing policy debate over government-mandated benefits [6; 9; 10; 13; 17; 22; 24; 27]. Current government mandates or "statuatory employee benefits," include social security, unemployment insurance, workers' compensation, maternity leave, etc. However, policy initiatives at every level of government routinely recommend new mandates. Among today's proposals, targeted employers would be required to offer new benefits from childcare to health care. Debates over proposals for new government mandates usually center on two related questions: i) do the advantages outweigh the costs?, and ii) what are the alternatives?

   Assuming government intervention can be justified [17], those in favor of employer mandates contend compulsory benefits packages are less disruptive than a government tax/transfer program that offers the same benefits [22]. If employer-provided benefit mandates are fully valued by employees, wages fall to offset the cost of benefits, and there will be no efficiency cost. Alternatively, when government-provided benefits are financed with a tax, there is a deadweight loss.

   A generally conceded drawback of employer mandates is that they often ignore part-time workers and the unemployed [5]. However, critics of employer mandates go further, emphasizing that higher mandated labor costs creates unemployment [11], and/or induces firms to rely more heavily on part-time workers [15; 21].

   If instead of shedding labor or turning to part-time workers, targeted employers reduce wages (or wage growth) to offset the costs of new mandates,(1) then employee valuation becomes the central issue. For example, employees who prefer cash to the new benefits might keep their jobs, but their well-being declines. This paper offers a straightforward extension of the traditional utility maximization framework to help analyze employee responses, when employers offset benefit mandates with lower wages.

   A careful analysis of worker and firm responses to mandates underlies any attempt to uncover advantages and costs of government-mandated benefits. As Mitchell recently concludes, an important aspect of the problem is the "need to know more about why workers differ in their demand for benefits" [17, 315]. The model provides insights into employee responses to policy proposals such as new benefit mandates (and new personal income tax rates). Recent proposals to reform health care provide an illustration?

   Prominent among both federal and state health-care reform efforts are recommendations mandating employer-paid premiums for minimum "standard" health-care packages. A danger is that firms perceive such mandated increases in benefit obligations similar to a payroll tax.(3)

   Given the globally-competitive nature of production, five management policy responses can be identified to preserve a firm's competitiveness: i) adopt technology that substitutes capital for labor and/or use part-time labor (to shrink the labor force affected by mandates), ii) move operations "offshore" (to lower productivity-adjusted labor costs), iii) improve the product (to justify higher prices and cover increased labor costs), iv) raise labor productivity (to offset higher labor costs),(4) or v) reduce non-mandated compensation (to offset legislated increases in benefits). The first four management responses are long-run policy options, and involve significant up-front costs. These include, respectively; capital purchases and severance pay, relocation expenses, product R&D, and training expenses. Given the deterrent of these up-front costs, and some recent empirical evidence [8; 9; 10], this study explores the impact on employees of mandated changes in benefits under the final "short-run" option.

   The paper examines the prospect that targeted employers adjust wages to compensate for legislated increases in benefits. Although studies on the effect of benefit mandates on wages are fraught with data and estimation problems, a number of studies offer empirical evidence in support of this response. For example, in a careful study of the public sector, Ehrenberg and Smith [8] found a one-for-one trade-off between wages and employer-provided benefits. Moreover, noting that mandated health insurance plans are similar to existing workers' compensation programs, and that workers' compensation varies widely between states, Gruber and Krueger [10] estimate that (for five high-cost industries) 85% of workers' compensation costs were passed on to employees through lower wages. Most recently, Gruber [9] uses the Current Population Survey to study the extent to which the cost of a group-specific mandate (childbirth benefits) was shifted to the targeted group's wages. He finds "substantial shifting to wages (on the order of 100% of the cost of the mandate), with little effect on total labor input" [9, 4].

   While this short-run management response, adjusting wages to compensate for increased benefits, avoids significant up-front costs to employers, it nonetheless involves sacrifice on the part of certain employees. The model suggests that while one category of employee may be indifferent (or even prefer) this adjustment, attracting and retaining another category is problematic. If employers require employees in the latter category, they have three management options: a) modify the wage adjustment, b) modify existing "voluntary" benefits, or c) offer new benefits. An exploration of these options provides a natural development of the model, and offers a starting point to help policymakers analyze ripple effects of government-mandated benefits.

   The framework is developed assuming competitive labor markets where employees have alternative employment opportunities and employers pay the going market wage. Examples include the market for most professional, administrative, technical, clerical, production, and service employees. Along with a salary or "wage," business and government employers typically offer three categories of benefits: "in-kind," "lump-sum income," and "price savings."(5)

   Employer-paid health insurance (or "noncontributory medical care") provides an example of an in-kind benefit. Although the cost to the employer is the same, the value of the benefit to some employees is modified if the dollar equivalent of a premium payment is disbursed directly as lump-sum income. An employer-subsidized discount on health insurance (or "contributory medical care") provides an example of price savings. An important result of this analysis is that management implications of a policy change depend on which category of benefit is impacted.

   Understanding the role benefits play in compensation is critical to most companies since over the past 40 years, growth in benefits have outstripped wage increases. Employee benefit plans first grew substantially during World War II and the Korean War when a policy of wage freezes was in effect. At that time, employee benefits became an important factor in attracting and retaining employees. Since then, ". . . the rate of growth on outlays for . . . benefits has substantially outpaced that for wages and salaries . . ." [3, 2]. More recently: "nonwages grew from just under 20% of total labor cost in 1965 to over 27% in 1985," although "the growth of benefits as a share of compensation slowed during the 1970's and came to a halt in the mid-1980's" [27, 273, 291].

   For purposes of this analysis it is useful to divide "benefits" into the three broad categories proposed above: (1) "in-kind," (2) "lump-sum income" payments, and (3) "price savings." Examples of the first category include "noncontributory" medical and dental care. Nonproduction bonuses and paid vacations provide examples of lump-sum income payments.(6) Finally, the benefit of price savings is enjoyed by those who, by virtue of working for an organization, have access to subsidized childcare, recreation activities, etc. Interestingly, whereas it costs employers to provide in-kind benefits and lump-sum income payments, the employer may or may not subsidize price savings enjoyed by an employee. For example, by virtue of working for a large organization, employees often receive discounts at restaurants, movie theaters, etc., at no cost to the employer.(7)

   Table I. Selected Benefits and Percent Participation/Eligibility, 1989(*)

   (1) In-Kind Benefits(**) Employee Coverage 48%

   Medical Care Family Coverage 31% Employee Coverage 34%

   Dental Care Family Coverage 25% Life Insurance 82% Free Parking 90%

   (2) Lump-Sum Income Benefits(***)

   Nonproduction Bonuses 27% Gifts 24%

   (3) Price-Savings Benefits(**) Employee Discounts 54% Employer-Subsidized Recreation 28% Subsidized Meals 23% Employer Assistance For Child Care 5%

   * Data taken from Bureau of Labor Statistics, Employee Benefits Survey, 1990 [3].

   ** Percent of full-time employees participating in selected wholly employer-financed employee benefits, medium and large firms.

   *** Percent of full-time employees eligible for selected employee benefits, medium and large firms. Table I provides a breakdown of selected benefits into the three broad categories. The percent of full-time employees that participated in (or were eligible for) these benefits in 1989 is reported. The results are taken from a U.S. Department of Labor survey of medium and large firms [3]. In the case of In-Kind benefits, the percent of full-time employees participating in wholly-employer-financed benefit programs is reported. The percent of eligible full-time employees is reported under Lump-Sum Income payments and Price Savings.

   Table II highlights in-kind medical care benefits. It reports the percent of wholly employer-financed (or "noncontributory") employee and dependent coverage by "HMO" and "OTHER" medical plans in medium and large firms in 1981 and 1989. The data reveal a decade-long decline in noncontributory medical care coverage.

   Whereas noncontributory HMO coverage remained constant or increased slightly over this period, a...