Health Care Reform and Small Business

Jane G. Gravelle
Senior Specialist in Economic Policy


An issue in the development of the new health care reform legislation is the effect on small business. One concern is the effect of a "pay or play" mandate to require firms to provide health insurance for their employees or pay a penalty. Current proposals have exemptions for small businesses, and also propose to provide subsidies for purchasing insurance. Economic theory suggests that health insurance costs (and any penalties) should be passed on to labor income, but that may be more difficult for employers of lower-wage workers. Furthermore, average wages are generally smaller for small firms (except for the smallest). A second concern is the potential effect of the surcharge on high-income individuals, which has been proposed as a funding mechanism in the House proposal, and its effects on owners of small businesses. 

Both the House bill (H.R. 3962, passed on November 14, 2009) and the Senate bill (H.R. 3590, passed on December 24, 2009) would exempt small businesses from penalties. The House bill would apply no penalties to firms with $500,000 or less in payroll, and the Senate bill would exempt firms with 50 or fewer employees. As a result, very few smaller businesses would be affected. The House bill would exempt over 80% of firms and the Senate bill would probably exempt about 95%. The House plan would exempt fewer firms over time because the exemption is not indexed. The share of firms that would not be affected either because they are exempt or because they already offer insurance would be larger, probably around 95% to 98%. About 20% of employees work for firms that were estimated to be affected. 

The penalties in the Senate bill are per-employee flat dollar amounts of $750 for firms that do not offer coverage, triggered if one or more employees are eligible for the premium credit for lower income families. They are relatively small compared with the cost of health insurance. Firms that offer insurance also will pay penalties if their employees enroll in individuals plans and receive the premium credit, only for those employees. The penalties appear smaller than those in the House proposals, which are calculated as a percentage of payroll. The proposals also provide temporary credits to subsidize small employers' contributions to insurance for lower-income employees that depend on firm size and employee compensation. The credits are the same in the two bills (except that the Senate bill allows a higher compensation phaseout), and would be as much as 50% of the employer's cost. The subsidy for taxable firms is provided as a nonrefundable income tax credit and would not benefit firms with no income tax liability; the Senate bill, however, has a separate 35% credit for nonprofits. 

Because most small businesses are subject to the individual income tax, high-income business owners could be affected by the proposed surcharge that would be imposed (for couples) at 5.4% on incomes over $1 million ($500,000 for singles) in the House bill. The surcharge affects 0.3% of taxpayers; 1.2% of unincorporated businesses are affected. Concerns have been raised that the surcharge on adjusted gross income would have adverse effects on small business and, in turn, on job creation. The top 1% of taxpayers receive more than half of the income of unincorporated business, but some income is passive (reflecting investment rather than operating a business). Some is active income received by professional services (e.g., doctors, attorneys, financial advisors). These activities may be less related to job creation, often associated with new entrepreneurial firms. The job creation justification is problematic on several grounds. It would be possible to exclude certain types of business income from the surcharge at a small cost if passive income and certain income (e.g., finance, insurance, real estate, professional services) were not eligible for the exclusion. 

Date of Report: January 4, 2010
Number of Pages: 16
Order Number: R40775
Price: $29.95

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