Photographer: Joe Raedle/Getty Images
Photographer: Joe Raedle/Getty Images

A recent Congressional Budget Office report on the economy added fuel to conservative criticisms of the Affordable Care Act, suggesting that U.S. workers will work up to 2 percent fewer hours -- equal to about 2.5 million workers dropping out of full-time work.

But beyond the obvious political criticism, the CBO report should give both liberals and conservatives pause in their preference for means-tested programs for poor and moderate-income Americans.

Means-tested programs such as Obamacare that tie benefits to income can create large effective tax increases once an individual reaches a certain income threshold and loses benefits that were available below that threshold. This discourages low-income Americans from working more, or pursuing other opportunities to climb the economic ladder.

Reforming safety-net programs such as Obamacare so that they don’t penalize working more hours or taking a better job would allow both parties to claim victory in the battle against inequality -- helping more poor families to lift themselves out of poverty along the way.

The health-care law's pernicious labor market and tax effects have been widely discussed, and not only in conservative economic circles. In 2012, David Gamage, a former Obama administration Treasury official, wrote that the law created high marginal tax rates for some eligible enrollees (those people who earn up to about 200 percent to 250 percent of the federal poverty level). And because employers are penalized for not offering “creditable coverage," Gamage also noted that it would actively discourage employers from hiring some low or moderate-income workers when the cost of maintaining mandated coverage exceeds the economic value of their labor.

Economist Casey Mulligan picked up on this theme last summer, writing that Obamacare's generous subsidies will encourage more workers to work part time, even when their employer offers health insurance for full-time employees.

This is because employees still pay significant costs out of pocket for their coverage. In Mulligan’s example, a full-time employee costs her company about $56,000 in total compensation, including family coverage. The employee’s annual share of her insurance costs (including premium contributions and co-pays) comes out to $7,667. A part-time worker with Obamacare coverage, on the other hand, would only pay $4,342 in total out-of pocket-costs -- 44 percent less, thanks to generous taxpayer subsidies.

Rather than bluntly assail the ACA as a “takeover” of U.S. health care, conservatives need to recognize that government’s distorting role in labor and health insurance markets started more than 60 years before Obama took office -- during World War II, when employers were first allowed to offer employer-provided health insurance as a tax-free benefit to employees.

Today, large employers fiercely protect the employer tax exclusion because it allows them to compete for labor more cheaply than if they had to offer compensation that was taxed as wages. (A dollar of wages is taxable for both the employee and the employer, while a dollar of health-care compensation is untaxed for both of them.)

Unfortunately, rather than confronting the tax problem head on, Obamacare offers a confusing hodge-podge of premium tax credits and cost-sharing subsidies as an alternative to employer coverage. But, as the CBO report implicitly shows, the Affordable Care Act expands insurance coverage at the cost of creating yet another tier in the U.S. health-insurance caste system, giving some workers more generous tax subsidies than others with employer-based coverage, depending on the number of hours they work.

The solution is to equalize and cap the tax preference for health insurance between the ACA exchanges and employer-provided insurance (a Republican Study Committee proposal from last year envisioned such an arrangement), while also eliminating the employer mandate. A flat-tax credit (tied to catastrophic coverage and health-savings accounts) that was available to all Americans would remove the Obamacare penalty that accrues to working more hours, and would encourage economic mobility because the choice of where to attain insurance would be entirely tax neutral. Employers could still pool the credits for their employees, and purchase group coverage, or make it easier to purchase insurance through private insurance exchanges.

While the CBO report is unlikely to lead to substantive reforms of the Affordable Care Act's subsidy system or the tax treatment of employer-provided insurance any time before the November midterm elections, the odds may increase sharply if Republicans take back the Senate.

In that event, President Barack Obama would feel pressure to compromise. So might Republicans. Why? As they wouldn't be able to overturn the president’s veto in any case, they might have political incentive to show they can work with the White House, rather than just fight it. Using the exchanges as a vehicle for further market-based reforms for Medicare and Medicaid might attract additional support from pragmatic conservatives.

By focusing on the law's labor-market distortions, both parties could agree on how to fix some of Obamacare's most pressing problems, without having to concede their core convictions.

No safety-net program has been passed by Congress without being subject to significant, sometimes far-reaching, changes. And doing so could significantly improve Obama’s signature domestic achievement, without scuttling it and starting over.

(Paul Howard is a senior fellow and director of the Center for Medical Progress at the Manhattan Institute.)

To contact the writer of this article: Paul Howard at phoward@Manhattan-Institute.org.

To contact the editor responsible for this article: Katy Roberts at 1+212-205-0373 or kroberts29@bloomberg.net.