The health wedge and labor market inequality

Over half of the US population receives health insurance through an employer with premium contributions creating a flat “head tax” per worker, independent of their earnings. This paper develops and calibrates a stylized model of the labor market to explore how this uniquely American approach to financing health insurance contributes to labor market inequality. We consider a partial-equilibrium counterfactual in which employer-provided health insurance is instead financed by a statutory payroll tax on firms. We find that, under this counterfactual financing, in 2019 the college wage premium would have been 11 percent lower, noncollege annual earnings would have been $1,700 (3 percent) higher, and noncollege employment would have been nearly 500,000 higher. These calibrated labor market effects of switching from head tax to payroll tax financing are in the same ballpark as estimates of the impact of other leading drivers of labor market inequality, including changes in outsourcing, robot adoption, rising trade, unionization, and the real minimum wage.