Wednesday, November 16, 2011

Break Out the Dentures

On Monday, the Supreme Court agreed to review the constitutionality of ObamaCare. That prompted me to sketch out the core principles of ObamaCare. Today I'll discuss the penalty regime in more detail. The penalty regime is arguably the lynchpin of the entire health care "reform" legislation. And it was designed to have no teeth, legally or economically. Call in the dentists.

Core Principles

The crux of ObamaCare is the individual mandate. The individual mandate requires most individuals and families to obtain "minimum essential" health coverage. The individual mandate is critical, because ObamaCare requires insurance companies to provide coverage to older, sicker individuals (i.e., individuals with "pre-existing conditions"). And it prohibits insurance companies from charging higher premiums to sicker individuals (within age bands).

Because ObamaCare will "expand" insurance coverage to older, sicker individuals, it will increase costs to existing participants in health insurance schemes. The costs of older, sicker participants will get transmitted to other participants, increasing premiums. To neutralize this cost spike, Congress needed to persuade/coerce more younger, healthier individuals to purchase coverage.

ObamaCare employs a "carrot" and "stick" approach to persuade/coerce the uninsured to purchase health insurance. The "carrot" involves tax subsidies for low- and middle-income households who purchase coverage through state exchanges. The "stick" involves a penalty regime applicable to individuals and families who do not obtain qualifying health coverage.

Toothless Penalties

I summarized the penalty regime on Monday. The penalty is the greater of a flat dollar amount per individual taxpayer that rises to $695 in 2016 and is indexed by inflation thereafter (with caps for children and families) or a percentage of the taxpayer's household income that rises to 2.5 percent for 2016 and subsequent years (also capped). See examples here.

Based on a CBO/JCT report, Congress assumed that approximately 1% of the population would be subject to penalties after ObamaCare is fully implemented. CBO/JCT estimates that approximately 21 million individuals will continue to be uninsured. However, only 4 million of them have sufficient household income to be dinged by the penalty regime.

Let's step back for a moment. A "penalty" is a punishment for some action or omission. If you drive faster than the speed limit, you get a speeding ticket and pay fines. If you don't have minimum essential coverage, you are supposed to pay a penalty (as described above). But Congress assumed that roughly 80% of the individuals who do not comply will be exempt from penalties. They are not deemed economically capable of compliance, so they are not punished for non-compliance. Does it make any sense to establish a penalty regime that provides an 80% exemption rate?

Ultimately, the penalty regime is window dressing to support deeply flawed legislation. Congress did not want the penalties to have teeth, legally or economically.

No Legal Bite

Democrats in Congress preach a "free lunch" gospel to low- and middle-income voters. The Democratic Gospel of Free Lunch says that the federal government can (i) create or expand social welfare programs, and (ii) "pay" for the costs by increasing taxes on the "wealthy." They want to balance a pyramid on its tip. Longer term, it's an unsustainable strategy. A pyramid won't balance on its tip, and we're heading towards the fiscal abyss. Shorter term, the Democratic Gospel is an effective way to rally support and votes.

Republicans argued that ObamaCare could only be financed through across-the-board tax increases. Democrats were sensitive to this charge for ideological and practical reasons. ObamaCare needed to provide benefits to low- and middle-class voters without increasing their taxes. President Obama vocally and publicly argued that the penalty for non-compliance with the individual mandate was not a "tax." Democratic leaders feared that a rigorous penalty regime would be viewed as a de facto tax on the uninsured (generally low- and middle-income households). The ObamaCare penalty regime was designed to have no legal bite.

The penalty regime will be administered by the IRS. Now, along with auditing tax returns, the IRS will need to track whether individuals and families maintained health coverage each month during the calendar year. Congress might as well have required the IRS to develop and launch a new Mars Rover. It's inconceivable that the IRS will be able to develop a system that (i) tracks whether 360 million Americans have health coverage each month, (ii) flags all non-compliant individuals on a timely basis, (iii) filters out the 16 million Americans who are expected to be exempt from penalties, (iv) provides timely notice of penalty to the 4 million Americans who are expected to owe penalties, (v) provides an efficient dispute resolution mechanism (for errors), and (vi) collects penalties on a timely basis. Congress is okay with IRS dysfunction. In this case, a dysfunctional administrator is consistent with the Democratic Gospel.

If the IRS somehow determines that an individual is non-compliant and owes penalties, the IRS is not permitted to file liens or levies to collect the penalties. In other words, the IRS can only "collect" the penalty out of refunds owed to the taxpayer in question. A taxpayer can "opt out" of the penalty regime by underpaying estimated taxes during the course of the year. Any individual with positive tax liability for a given calendar year will not be required to "pay" anything. Presumably, cumulative "penalties" will carry forward into successive tax years until cumulative refunds are offset against the penalties. Again, there is a huge timing disconnect; the IRS typically issues refunds before examining tax returns. Will the IRS system be able to "match" non-compliant taxpayers and their "penalties" before refunds go out the door?

No Economic Bite

The ObamaCare penalty regime also lacks economic bite. Let's assume miraculous administration (i.e., the IRS timely assesses and collects "penalties" out of tax refund amounts). In 2016, the penalty for a non-compliant individual will be approximately $700. The projected average cost of an individual employer-sponsored insurance policy is approximately $8,300.

(Remember, subsidies under ObamaCare will encourage more people to purchase health insurance. As demand for insurance rises, insurance premiums will increase. Plus, insurance companies will be required to cover more older and sicker individuals, spreading higher costs to other participants.)

Go back to my post from Monday. Let's say I'm a young, single, uninsured Gambler with no dependents. I make enough money to cover rent, car loan payments, school loan payments and recreational opportunities. Even with subsidies under ObamaCare, I can't afford an $8,300 annual policy. I can easily afford a $700 penalty. Plus, I've heard that insurance companies must offer me coverage at any time, irrespective of my health status (no discrimination for "pre-existing conditions"). I can cruise along for the time being without health coverage. If I get very sick or seriously injured, I'll enroll in a health insurance scheme through one of the state exchanges.

The drafters of ObamaCare understood the perverse economic incentives. They could have given the mandate some economic bite, simply by linking penalties to average insurance premiums on the taxpayer's resident state exchange. But again, a rigorous penalty regime would be inconsistent with the Gospel of Free Lunch. Democratic leaders were not attempting to create a penalty regime with teeth. They just needed to put some lipstick on a pig.

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