November 8, 1999
Nickles Minimum Wage Bill Includes
Costly Tax Cuts That Could Harm Lower-Wage Workers
by Iris J. Lav
Legislation Senator Don Nickles has put forth on behalf of the Republican leadership to increase the minimum wage by one dollar over three years, which is expected to be taken up on the floor this week, includes a set of tax breaks that not only would largely benefit higher-income individuals but that also are likely to lead to reductions in employer-provided pension and health benefits currently available to lower-wage workers.
The bill features a series of changes in tax laws related to pensions that would make pension tax breaks considerably more lucrative for highly paid executives and other highly compensated individuals. Some of these pension provisions would allow smaller employers to retain or increase coverage for the owners and higher-paid employees while reducing coverage for more moderately-paid workers.
A costly new "above-the-line" deduction for health insurance premiums paid by individuals who purchase their own insurance or whose employers subsidize less than 50 percent of the cost of health insurance premiums also is included. This provision is likely to do little to make health insurance affordable for most of the nations uninsured, 93 percent of whom either owe no federal income taxes or are in the 15 percent bracket and thus would at most receive a subsidy of 15 cents for every dollar spent on health insurance. Moreover, because the deduction would provide a far deeper percentage subsidy for purchasing health insurance to higher-paid business owners and executives than to lower-wage earners, it could even encourage small business owners to drop group coverage (or not to institute it in the first place) and to rely on the deduction for their own coverage. To the extent this occurs, the ranks of the uninsured among lower-wage workers could increase.
The net cost of the tax provisions in the Nickles minimum wage bill would be $18 billion over the next five years, and $76 billion over ten years. By the tenth year, the annual cost would be more than $16 billion.
This cost is not paid for; it is simply assumed to be covered by the non-Social Security surplus. That surplus, however, has yet to materialize; projections of a sizeable non-Social Security surplus rest on the assumption that Congress will make substantial cuts in discretionary spending, an assumption that action on the current appropriations bills belies. Whether a non-Social Security surplus of any magnitude will materialize remains to be seen. Furthermore, this bill would make its inadequately designed and targeted tax cuts the first claim on such a surplus, ahead of needs in Social Security, Medicare, other emerging needs, and paying down more of the debt.
The argument usually advanced for including tax measures as an accompaniment to a minimum wage increase is that small businesses need to be compensated for the increased wages they would have to pay under a higher minimum wage. This argument is not well-founded; the evidence does not indicate that modest minimum wage increases have significantly negative effects on small businesses. For example, recent research that examined whether minimum wage increases contribute to the failure rate of businesses found "...there seems to be no discernible correlation between minimum wage increases and a rise in business failures, either in the year the increase occurred or in the following year." (1) But whatever the merits of compensating small businesses, the tax cuts in the Nickles bill go far beyond any reasonable bounds for what might be justified as measures to cushion the effects of a higher minimum wage on small businesses. In addition to providing costly tax breaks to high-income taxpayers, most of whom do not work in small businesses, the tax cuts have the potential to hurt the very workers minimum wage legislation is intended to help.
Pension Provisions Are Poorly Targeted
The Nickles minimum wage legislation includes the pension tax provisions of the tax bill Congress passed and the President vetoed this summer. These provisions have at most a tenuous connection to any problems that small businesses are said to experience as a result of a minimum wage hike.
The proposed pension changes would relax various provisions of current law that limit the contributions that highly paid individuals may make to pension plans, as well as the amount of the pension payments that such high-income individuals may receive when they retire. For example, the bill would increase the maximum tax-favored contribution that an employed individual is permitted to make to a 401(k) plan from $10,000 to $15,000. This change would primarily benefit the fewer-than-five-percent of individuals covered by a 401(k) plan who make the maximum $10,000 contribution today; this is a group that receives average pay of $130,000. The bill also would increase the maximum benefit that a retiree can receive under a defined benefit pension plan from $130,000 a year to $160,000. That change would benefit only those at the very top of the income distribution whose salaries are so large that they would be able to qualify for annual pension payments of more than $130,000 when they retire.
These and the other pension-related tax breaks in this bill have little to do with assisting small businesses. Most small businesses, in fact, do not even offer pension plans. In 1993, only 13 percent of full-time workers in firms with fewer than 10 employees and 25 percent of workers in firms with between 10 and 24 employees enjoyed pension coverage. It is unlikely that many small businesses with large minimum-wage workforces would be affected by these expansions in pension tax breaks.
By contrast, 73 percent of workers in firms with 1,000 or more employees have pension coverage.(2) Most of the benefit of the pension provisions in the Nickles bill would accrue to highly-salaried executives of large corporations that already offer generous pension coverage.
An analysis by the Institute on Taxation and Economic Policy finds that 91 percent of the tax benefits from the pension provisions in the vetoed tax bill would go to the 10 percent of Americans with the highest incomes. By contrast, the bottom 60 percent of Americans would receive less than one percent of these tax benefits. The effect of these provisions would be a significant increase in the tax-preferred benefits of high-income individuals, with little expansion for the moderate- and low-income workers many of whom work for small businesses who most need to build savings for retirement.
In fact, some of the pension provisions could lead to reduced coverage for some low- and middle-income workers. For example, the bill would raise the amount of salary on which pension contributions may be made from $160,000 to $200,000. This would enable small business owners and highly-paid executives to maintain contributions for their own pension plans while reducing the firms contributions for other employees. Consider, for instance, the case of a small business owner with compensation of $250,000 who wants to have the business contribute $10,000 a year to his pension. Under current law, the owner would have to set the firms pension contribution rate at 6.25 percent of pay (6.25 percent of the $160,000 limit is $10,000). Both the owner and the employees would receive contributions equal to 6.25 percent of their compensation. Under the higher $200,000 limit the Nickles bill would set, however, the business owner could reduce the firms contribution rate for its employees to five percent and still have the firm contribute $10,000 to his own pension. The employer contribution for an employee earning $40,000 would drop from $2,500 (6.25 percent of $40,000) to $2,000 (5 percent of $40,000).(3)
Provisions in the Nickles bill also would relax pension anti-discrimination rules and other rules barring firms from treating highly compensated employees more generously than average workers. These provisions could induce further erosion in coverage among low- and moderate-paid workers.
In a November 1 letter to House Ways and Means Chairman Bill Archer commenting on the identical pension provisions in the minimum wage legislation the House is considering (H.R. 3081), Treasury Secretary Lawrence Summers and Labor Secretary Alexis Herman raise concerns about the provisions in the bill that "...raise the maximum retirement plan contribution and considered compensation for business owners and executives and weaken the pension anti-discrimination and top-heavy protections for moderate- and lower-income workers." The letter emphasizes that the "...provisions are regressive, would not significantly increase plan coverage or national savings, and could lead to reductions in retirement benefits for moderate- and lower-income workers."
Health Insurance Deductions Little Help to Uninsured
Another provision of the vetoed tax bill that is included in the Nickles minimum wage legislation would create a new tax deduction for the purchase of health insurance by taxpayers who pay at least 50 percent of the cost of their health insurance premiums. At first glance, such a deduction may seem an attractive idea if it could help the uninsured obtain coverage or help small businesses cover their employees. Closer examination indicates, however, that this deduction which would cost upwards of $8 billion a year when fully in effect would provide little help to most of those lacking insurance and would not significantly reduce the ranks of the uninsured. Moreover, because the deduction provides a far deeper percentage subsidy for the purchase of insurance to higher-income business owners and executives than to lower-income wage earners, it could encourage small business owners to drop group coverage and rely on the deduction to help defray the cost of their own coverage. To the extent this occurs, the ranks of the uninsured could increase.
The deduction would provide little subsidy to lower-income wage earners, including most workers who currently are uninsured and those for whom employers pay inadequate shares of premiums to make insurance affordable.(4) Some 93 percent of all uninsured individuals either have incomes too low to incur income tax liability or pay income tax at the 15 percent marginal rate. These individuals would at most get a subsidy of 15 percent of the cost of purchasing health insurance. Rather than the uninsured or the workers who today cannot afford the premiums required to obtain adequate health coverage, those who would receive the largest benefits from such a deduction are, by and large, individuals in higher tax brackets who already purchase individual insurance.
For low- and moderate-income families and individuals without employer-sponsored coverage, a 15 percent subsidy that leaves them with the other 85 percent of the premium cost is much too small a subsidy to make insurance affordable.
For a family earning $35,000 whose employer does not offer insurance, the proposed deduction would reduce the out-of-pocket cost of a typical family health insurance policy that carries a $1,000 deductible from $6,700 to $5,860 or from 19 percent of income to 17 percent of income.(5) An Urban Institute study shows that more than three-quarters of low- and moderate-income uninsured individuals will not purchase insurance that consumes more than five percent of their income.(6) Few families that have forgone health coverage because they cannot afford to spend 19 percent of income on it would find coverage affordable because a deduction had lowered its cost to 17 percent of income. (It is of note that the child health block grant established in 1997 set a limit on the premiums and co-payments that can be charged under programs receiving block grant funds, with the limit being five percent of income for families above 150 percent of the poverty line and smaller amounts for poorer families.)
This provision might be of modest help to some moderate-income families whose employer pays half or nearly half of the premium costs since the deduction would be in addition to the employer subsidy. But even families whose employers pay 50 percent of the premium would receive only very modest help from the deduction. The deduction would reduce the proportion of the premium these families have to pay only from 50 percent of the premium to 42.5 percent. While that might help some families afford insurance, the number of such families likely would be small.
Moreover, the deduction could induce some employers currently paying more than 50 percent of premium costs to scale back their contribution to 50 percent or less or even to drop coverage.
The group that would appear to benefit most from this deduction would be higher-income taxpayers who purchase insurance as individuals. A health insurance deduction is worth more than twice as much to affluent individuals in the 31 percent, 36 percent, and 39.6 percent brackets than to moderate- and middle-income families in the 15 percent bracket.
The proposed new health insurance deduction would allow small business owners or more highly-paid employees to purchase insurance for themselves, using the more generous subsidy the deduction provides, without the necessity of providing coverage for lower-paid employees. As a result, the deduction could provide an incentive for some small business employers to drop group coverage, or for some owners newly launching small businesses to decide to decline to provide such coverage. To the extent this occurs, it would adversely affect some of the same workers the minimum wage legislation is supposed to help.
Two other provisions in the Nickles minimum wage bill are poorly targeted. These are the deduction for the purchase of long-term care insurance and the increase in the deduction permitted for business meals.
Deduction for Long-term Care Insurance
The bill includes a provision that would allow a new deduction for 100 percent of the premiums paid to purchase long-term care insurance. This provision would cost approximately $2 billion a year when fully in effect.
There are major problems relating to access to long-term care that need to be addressed. This proposal for a deduction for long-term care insurance premiums, however, would not help most middle-income people and could exacerbate the inequities in access and affordability that currently exist.
Three-quarters of all taxpayers, including most moderate- and middle-income taxpayers, pay federal income taxes at no higher than the 15 percent marginal tax rate. For this three-quarters of all taxpayers, a deduction would provide at most a subsidy of 15 percent of the cost of purchasing long-term care insurance. Long-term care insurance premiums are relatively expensive, and a 15 percent subsidy is unlikely to make long-term care insurance fit into the budgets of many middle-income families.(7)
The primary beneficiaries of the proposed deduction are likely to be higher-income taxpayers who currently carry long-term care insurance, and taxpayers in the higher tax brackets for whom a 36 percent or 39.6 percent subsidy makes purchase of long-term care insurance an attractive option. But these are likely to be the same taxpayers for whom long-term care access is not a major problem.
Business Meals Deduction
The bill also includes a provision to increase the proportion of business meals that small businesses (businesses with receipts below $7.5 million a year) may deduct. Currently, businesses may deduct 50 percent of business meals and drinks. This limitation on the "three-martini lunch" is intended to prevent excessively luxurious dining and drinking at taxpayer expense. The Nickles bill includes a provision that would raise to 80 percent the proportion of business meals and drinks that can be deducted, at a cost to the Treasury of about $2.5 billion a year when fully in effect. (Note that this goes beyond the vetoed tax bill, which would have raised the deductible portion to 60 percent.)
1. Jerold Waltman, Allan McBridge, and Nicole Camhout, "Minimum Wage Increases and the Business Failure Rate," Journal of Economic Issues, March 1998.
2. U.S. Department of Labor, Social Security Administration, Small Business Administration, and Pension Benefit Guarantee Corporation, Pension and Health Benefits for American Workers, 1994.
3. The pension tax provisions in the vetoed tax bill, all of which are included in the Nickles minimum wage legislation, are explained more fully in the Center report, Exacerbating Inequities in Pension Benefits: An Analysis of the Pension Provisions in the Tax Bill, by Peter Orszag, Iris Lav, and Robert Greenstein, October 8, 1999. The vetoed tax bill also included provisions that would make Individual Retirement Account tax breaks more generous; these IRA changes are not included in the Nickles minimum wage bill. (The distribution data cited above on the tax benefits that the Nickles bill pension provisions would provide thus do not cover the IRA expansions of the vetoed bill. Data on the distributional effects of the full package of retirement tax benefits contained in the vetoed bill, including the IRA expansions, are provided in Exacerbating Inequities in Pension Benefits.)
4. Census data show that at least 93 percent of uninsured individuals either pay no income tax or are in the 15 percent income tax bracket. Some 18 million uninsured individuals 43 percent of all of the non-elderly uninsured owe no income tax; their earnings are too low for them to incur an income tax liability. These uninsured individuals would receive no benefit from a tax deduction; a deduction would do nothing to make health insurance more affordable for them. Another 20 million uninsured individuals 50 percent of the non-elderly people without health insurance pay income tax at a 15 percent marginal tax rate. A deduction would provide these taxpayers with a subsidy equal to 15 percent of the cost of insurance not covered by an employer. General Accounting Office, Letter to The Honorable Daniel Patrick Moynihan, June 10, 1998, GAO/HEHS-98-190R, Enclosure II. The analysis is based on the 1996 Current Population Survey.
5. A General Accounting Office study found that in 1996, the middle of the range of premium costs was $5,700 for a family-coverage policy that included a $1,000 deductible. The proposed tax deduction would provide a subsidy of $840 for the purchase of a policy with a $5,700 premium ($840 equals 15 percent of $5,700). This means the family would have to pay the remaining $4,860, or 14 percent of its income, to purchase the health insurance policy. Since this premium is for a policy with a $1,000 deductible, another three percent of income would have to be expended before any benefits would be available. The familys net expenditure for health coverage the premium plus the deductible would total $5,860, or 17 percent of the familys income. Without the proposed tax deduction, the full cost of the policy plus the $1,000 deductible is equal to 19 percent of the familys income.
6. Leighton Ku, Teresa Coughlin, The Use of Sliding Scale Premiums in Subsidized Insurance Programs, Urban Institute, March 1997.
7. Long-term care premiums vary by the age at which the policy is purchased and the type and amount of long-term care expenses the policy will reimburse. A 1997 study by Consumers Union found premiums at age 55 ranged from $588 to $1,474 a year, while premiums at age 65 ranged from $1,042 to $3,100 a year. These policies cover individuals, so the costs for a couple would generally be double those amounts. Consumer Reports, October 1997.