Who pays for public employee health costs? Data analysis




After a hiatus during the Great Recession, health spending and health costs are once again rising fast. This trend is likely to continue: More than 70% of cost increases are due to the rising cost of treatments themselves, rather than increased patient numbers or illnesses, with rapidly rising hospital charges just one example. With one in seven Americans working in state or local government, the question of how governments pay for employee healthcare is not insignificant. From 2002 to 2010, state and local government spending on employee healthcare rose by 67% in real terms, to $117 billion dollars (in 2012 dollars); at the same time, state and local government finances are being squeezed by low revenue growth and by rapid rises in pension and other health obligations, threatening to destabilize state and local governments’ fiscal sustainability.

State and local governments have been finding various ways to deal with the revenue-expenditure mismatch. In 2002 no states offered a high-deductible health plan to employees, but 28 states had done so by 2012. In New Orleans, after rapid depletion of a $500 million reserve fund for state employee and retiree health costs, a new regime will introduce both insurance premium increases and health benefit reductions. After extensive reductions in the generosity of the existing health insurance plan, Wisconsin has considered self-insuring state employees in a bid to cut costs. Meanwhile, a class-action lawsuit in Georgia alleges that state employees were overcharged more than $10 million a month in excess health insurance premiums as part of a state money-saving drive.

In a 2014 study for the National Bureau of Economic Research, “Who Pays for Public Employee Health Costs?” economist Jeffrey Clemens of the University of California, San Diego, and Harvard University economist David Cutler calculate who has borne the burden of rising health care costs for state and local government employees. They look at six ways that state and local governments could deal with rising employee health costs: reducing the cost of employment by reducing employment levels; reducing wages or reducing the generosity of the health benefit package; reducing other expenditures on (non-labor) inputs; or increasing revenue by raising taxes or adding to the deficit. (The study is forthcoming in the Journal of Health Economics.)

They first use state-level data over 2006-2012 to investigate the question:“To what extent and under what conditions have state governments shifted the costs of health insurance back to workers, in the form of less generous coverage?” Clemens and Cutler find that:

  • Health insurance premiums for state workers have grown much less rapidly than premiums for comparable private sector employees in recent years.
  • The share of insurance premiums paid by state workers has been constant or rising, while it has been falling in the private sector.
  • States with a higher prevalence of public-sector unions have seen larger increases in employee cost contribution requirements. This seems to be because these states had lower employee cost contribution requirements to begin with.

The authors then analyze data from 6,429 school districts over 1998-2007 to reach a more comprehensive assessment of the effect of benefits on spending, revenue and the quality of service delivery. School districts are a useful unit of analysis because employee compensation accounts for nearly 70 percent of total costs, and because there is a sufficiently large sample to allow precise numerical estimation. Over the period 1998-2007, employee health costs rose from 14% to 17% of total school district expenditures. Health costs are one of the most rapidly increasing items on school districts’ books: Total school district costs rose by 50% per pupil over the period, while employee health benefit costs rose by 80% per pupil.

The authors find that:

  • Most of the increase of benefit costs was not offset by reductions in employee wages: “Roughly 15 percent of the cost of recent benefit growth was passed on to school district employees through reductions in wages and salaries… Each dollar of benefit growth is associated with an 85 cent increase in total compensation.”
  • The primary source of funding for this increase in total employee compensation was transfers from higher levels of government “from sources subject to significant discretionary reporting.” Nearly half of these increased transfers come from “two categories of revenue that previous research suggests are subject to manipulation by the school districts”: revenue for special needs, remedial, or bilingual students’ purposes, and “Other Programs” revenue tied to state transfers.
  • Teachers’ unions play an important mediating role in determining how the rising health care costs would be shared. “Districts with weak teachers’ unions appear to have offset increases in health care costs much more through reductions in the generosity of benefits.”
  • Health benefit growth was associated with increasing dropout rates. Using dropout rates as a proxy for student performance and the quality of service delivery, the authors suggest that “the reorganization of students required to increase flows of categorical aid may thus have worked to students’ detriment.” The authors note, however, that “we estimate this result with moderate precision on a sample severely constrained by data limitations … it should be treated with caution.”

Overall, the findings suggest that the majority of the increasing cost of public employee health benefits is not passed along to the employees through reductions in wages and salaries. Instead, the growth in benefits is associated with growth in overall compensation, and the increased costs are primarily borne by increased revenue from higher levels of government or by cost reductions elsewhere in the system. Strong unions appear to reduce the extent to which health costs are passed on through salary reductions, while poor economic conditions lead to increases in the passing on of health costs to employees. Clemens and Cutler conclude that the “outcomes of future bargaining over benefits will be particularly important for the finances of service-intensive governments like school districts, where employee compensation accounts for the bulk of total cost.”


Keywords: unions, organized labor, health care

    Writer: | Last updated: December 4, 2014

    Citation: Clemens, Jeffrey; Cutler, David M. "Who Pays for Public Employee Health Costs?" National Bureau of Economic Research, Working Paper No. 19574, 2013. Forthcoming in the Journal of Health Economics (2014).

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