Wal-Mart and Employee Health Insurance

Wal-Mart, the nation's largest private employer, has become embroiled recently in a number of controversies. One concerns health insurance. Wal-Mart provides health insurance to fewer than half its employees (though, as some critics neglect to note, many of the others are covered by spouses' health insurance or by Medicare), and it charges those employees whom it does cover a significant fraction of the total insurance premiums. Critics say, first, that Wal-Mart is being "miserly" toward its employees, who tend to be near the bottom of the economic ladder, and, second, that it is exporting medical costs that it should be defraying to publicly financed health systems, such as Medicaid, to which the uninsured who cannot afford to pay their medical expenses out of their own pocket turn. Some of the critics want employers to be required by law to provide health insurance for all their employees.

Economic analysis suggests that these criticisms, especially the first, lack merit, and that employer-mandated health insurance is not a good idea. This is not, however, because employee health insurance is likely to be more costly than individually purchased insurance, in which event it would be obvious why many employees would want to forgo it. Actually, it's likely to be less costly. Insurance is cheaper when all members of a group satisfying specified eligibility requirements are required to join the insurance plan, because without the compulsory feature those members having the lowest incidence of whatever risk is being insured against, such as the risk of incurring medical costs, would tend to drop out of the plan, since they would be subsidizing the higher-risk individuals in the plan; and the result of this dropping out would be an upward spiral in the cost of the insurance. That is why individual policies are more costly than group policies.

Another, and quite arbitrary, attraction of employee group health insurance is that like many other fringe benefits, it is not taxable. If an individual earns $50,000 and spends $5,000 to buy health insurance, he pays income tax on the full $50,000, and suppose the amount of the tax is $10,000 (20 percent). Then after paying for the health insurance policy he has $35,000 left. But if his employer pays him a salary of $45,000 (on which the income tax is, let us say, $9,000--which assumes the same 20 percent income-tax rate, though it might well be lower) and gives him a health insurance policy that costs the employer $5,000, the employee has $36,000 ($45,000 salary minus $9,000 tax) and so he is better off. But probably few Wal-Mart employees pay much income tax--which may be a partial explanation for why Wal-Mart does not offer health insurance to more of its employees.

It is entirely rational for a subset of employees, especially low-income employees, to prefer not to be covered by their employer's group health insurance policy even if they have no other health insurance. The basic reason is fact that from the employer's standpoint, the cost of a fringe benefit is no different from the cost of a wage. If the employer is prepared to pay an employee a salary of $45,000 and give him an insurance policy that costs the employer $5,000, then if the employee doesn't want the insurance the employer will be willing to pay him a salary of $50,000. Suppose the employee has no significant assets--a realistic assumption if he is a low-income employee. Then if he becomes ill he'll be able to obtain medical care free of charge under Medicaid, though it will be of lower quality than paid-for care. Suppose the value of that lower-quality care is only $3,000. Nevertheless the employee is better off without the insurance; his net income will be $53,000 ($50,000 in salary plus $3,000 in insurance value) versus $50,000 ($45,000 in salary plus an insurance policy worth $5,000) with the insurance.

Even if the employee is paid only the minimum wage (which for simplicity I'll assume is $5 an hour), so that the employer, were he to provide health insurance, would be forbidden to make a compensating wage cut, the employee would be better off without the insurance. Suppose the minimum wage, multiplied by 2000 (a 40-hour work week for 50 weeks), yields an annual wage of $10,000. If that is all that the employee's work is worth to the employer, the employer will not offer the insurance. If the employer does offer the insurance, say at a cost to him of $2,000, then he would be willing to pay the employee more than the minimum wage--an additional $1 an hour ($2,000 divided by 2000)--if the employee forewent the insurance and relied instead on Medicaid.

The second criticism of Wal-Mart's refusal to provide health insurance to all its employees who do not have other coverage has somewhat greater merit. There is an externality: employees who lack health insurance usually lack significant assets as well, so when they get sick the taxpayer pays their medical expenses. These employees thus externalize the costs of their medical treatment. This is true even though there is a sense in which a program like Medicaid does not eliminate the insurance principle but merely substitutes social for private insurance, with the taxes that pay for Medicaid corresponding to conventional insurance premiums. But only the poor are eligible for Medicaid, and they do not pay their actuarially fair tax to support the program. Otherwise there wouldn't have to be a Medicaid program.

But the externality cannot be fully eliminated by passing a law that would require Wal-Mart and other employers of low-income employees to insure all their employees. This is clearest in the case of minimum-wage employees who at present are not insured. Since the labor cost that an employer incurs is the sum of the wage he pays and the cost of any fringe benefits, forcing the employer to incur a total labor cost of $12,000 for an employee worth to the employer only $10,000 will simply cause that employee to be fired, with little prospect of obtaining another job; so he will lose his health insurance and be thrown back on Medicaid. Suppose instead that the employer is willing to incur a total labor cost of $12,000 for this employee, but the latter prefers a cash wage in that amount and no insurance, and now suppose as before that the employer is forced to insure him. The employer will reduce the employee's wage to $10,000, which may inflict significant hardship because the employee needs the cash more than he wants insurance (if he has no assets, he may well not need or want any health insurance). Notice the perverse redistributive effect: the average taxpayer, who is indeed made better off because the employee is now paying for his own health care, is wealthier than the average low-income employee.

The analysis is slightly complicated by the fact that if low-income employees have equally good alternatives to working for their current employer, they may not have to accept a reduction in wage equal to the increased cost to their employer of being forced to provide health insurance. Suppose in the example just given that although the health-insurance policy costs the employer $2,000, it is worth only $200 to the employee, so that he will perceive a reduction in his wage to $10,000 as a reduction in his full income from $12,000 to $10,200. And suppose that when he took the job with Wal-Mart he turned down an equivalent job with another employer that would have paid him $11,500 and that this job is still open. Then it might seem that Wal-Mart, to retain the employee, would have to pay him $11,300, since that amount, plus the $200 that is the value he derives from the health insurance policy, equals $11,500.

But this ignores the fact that the other employer, too, presumably is being subjected to the requirement of providing health insurance. It too will see its labor costs soar and therefore it will not pay as high a wage as before the requirement was imposed.

I mentioned that Wal-Mart is also criticized for making its employees pick up a big portion of the health insurance tab. But this may actually benefit the employees. Suppose that if Wal-Mart paid the entire tab, the average cost to the company of health insurance would be $5,000 per employee per year. If it charges the employee $1,000 a year in premiums, the cost to Wal-Mart will be only $4,000, so it will be willing to raise the employee's salary by $1,000. This may seem a complete wash, but it is not. For with the employee paying a big chunk of the premiums, the total cost is likely to be lower than $5,000, which would permit a net wage increase. The reason it is likely to be lower is that employees will economize on their demand for medical care if they incur a positive marginal cost for that care.