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 taxes on high-income individuals on small business. 

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. On March 22, 2010, the House passed the Senate bill (H.R. 3590) and the President signed it on March 23, 2010 (P.L. 111-148). The House bill would have applied no penalties to firms with $500,000 or less in payroll; the Senate bill exempts firms with 50 or fewer employees. While both proposals would exempt most firms, the Senate bill would exempt more, probably around 95%, and 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 98%. About 20% of employees work for firms that were estimated to be affected. 

Along with adopting the Senate proposal, the House passed a separate measure, H.R. 4872, which would alter the penalties and revenue sources in H.R. 3590; it was adopted with some modifications on March 25, and signed by the President on March 30 (P.L. 111-152). The penalties in the original Senate bill were per-employee flat dollar amounts of $750 a year 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. The reconciliation proposal would impose a larger penalty of $2,000 per employee, but exempt the first 30 employees. 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. 

The original Senate proposal had increased Medicare taxes on earned income on married couples with incomes over $250,000 and singles with incomes over $200,000 by 0.9 percentage points. H.R. 4872 extends the Medicare tax on high-income individuals to passive investment income by taxing that income at 3.8%. Some concerns had been raised earlier about the effect on small business of a high-income surcharge in the House bill, which would have imposed (for couples) at 5.4% on incomes over $1 million ($500,000 for singles). The surcharge would have affected 0.3% of taxpayers and 1.2% of unincorporated businesses. The Medicare tax on investment affects a larger total share of the population (2.6%) but is imposed at a smaller rate and is not likely to fall on small business owners whose capital is invested in their business because this income is either already subject to Medicare or is exempt.


Date of Report: April 8 2010
Number of Pages: 18
Order Number: R40775
Price: $29.95

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