The Hidden Cliffs in Obamacare

A hypothetical couple whom we’ll call Barbara and Harry Jones are 52 years old and have two children, and their household income is $94,200. She’s a freelance marketing consultant and he’s a plumber, so neither has health insurance from an employer. They live in Lancaster, Ohio, and they signed up for Obamacare just in time to make the deadline at the end of March.

Great news: based on their income, Barbara and Harry will get an annual $2,904 subsidy from the government to help pay an insurance bill that will be $12,288 a year for moderately good coverage. Obviously, the Joneses are not poor. But health care is now so expensive that President Obama’s law was designed to give even them help buying insurance.

Alice and Bob Smith (another hypothetical couple) and their two children live next door to the Joneses in Ohio. They too work in jobs–day care for her, light construction for him–that don’t provide health insurance. Their income is $94,300–meaning they’re keeping up with the Joneses and, in fact, beating them by $100. The Smiths will get no subsidy at all.

Now that enrollment in Obamacare has ended for the year, some of the quirks–maybe they should be called potholes–embedded in the complicated and heavily lobbied law are going to start to become visible. First among them may be the “cliff” problem that penalizes the Smiths to the tune of $2,904 for making $100 more than the Joneses. I can already see the headline on Fox News: “Obama’s Health Care Bureaucrats Tax Ohio Couple 2,904% for Making $100 More Than Next-Door Neighbors.”

It will be true. That’s because the Smiths’ income is just slightly more than four times $23,550, the amount defined by the government as living in poverty for a family of four. Under the Affordable Care Act, families like the Joneses who earn up to but not more than four times the poverty level get subsidies. After that, there is no subsidy. Sorry, Mr. and Mrs. Smith. Going over $94,200 is like going over a cliff. Unlike the way the federal graduated income tax is calibrated so that the Smiths never lose money by earning more, the subsidy doesn’t decline step by step. It plunges to zero.

Even steeper cliffs are possible. Suppose the Johnsons, each 63 years old, live in Florida and their kids are grown. They make $62,040 (four times the poverty line for a family of two adults) from the charter-boat business they run. They’ll get a subsidy of $9,024 to pay for their insurance. But they will lose it all if in 2014 they sell just one extra charter. If they make a dollar more (or $100 or $1,000 more) the entire $9,024 federal subsidy goes away. If their over-the-ceiling earnings are $100, that’s like a 9,024% tax on that $100.

“For hourly workers or freelancers who cannot predict their income with complete accuracy, this could be an anvil that comes down on them next year,” says Barry Cohen, an insurance broker in Lancaster who helped me model various scenarios. A middle-class couple, Cohen notes, could get a surprise $5,000 or $10,000 tax bill next April because they received a subsidy but then earned just a few dollars more than they estimated, pushing them above the income ceiling. As with much about the 906-page Affordable Care Act, you had to be in the room–actually many rooms, over hundreds of meetings over many months–when the law was written to understand how these startling cliffs came to be.

One of Obama’s goals, shared by many congressional Democrats worried about conservative opposition, was to keep the cost of the subsidies to the Treasury as low as possible. But in dozens of intense meetings, Obama and his staff, along with the congressional committee staffs, also struggled to make the insurance that people would be forced to buy as affordable as possible for as many people as possible.

Obviously, those two goals pulled in opposite directions. Lower federal subsidies meant higher premiums, but it also meant that the new law would cost less and therefore be easier for Congress to pass. So White House and congressional aides worked up two formulas to balance the competing pressures. The first mapped out how much the subsidies would be. The second defined who would qualify for them.

To determine the amount of the subsidies, the staffs adopted a graduated scale, like the income tax. Those earning at the poverty level would not be required to pay more than 2% of their income for the second lowest so-called Silver plan premium. (Those below the poverty level would qualify for Medicaid, a completely free program.) The plans on the insurance exchanges range from Bronze to Silver to Gold to Platinum depending on the amount of expected expenses–from 60% to 90%–you want the insurance company to pay, with you paying the rest.

Let’s assume that you’re a family of four with $24,000 in annual income (just above the poverty line), and the second cheapest Silver plan available to you costs $800 a month. Two percent of your annual income is $40 a month. That means you will get a $760 monthly subsidy ($800 minus $40), or $9,120 a year for health insurance. Those earning 200% of the poverty level (about $47,000), however, would be required to pay up to 6.3% of their income before they would get a subsidy. Those earning 300% to 400% would have to pay 9.5% of their income before the premium subsidy would kick in.

In other words, the more money you make, the less the government subsidizes your premium, which is just like the graduated-plan income tax in reverse.

However, when it came to who would get subsidies and who would not, the people who wrote the law provided for no sliding scale. Once the Smiths or the Johnsons score an extra construction job or boat charter that pushes their earnings over 400% of the poverty line, they get nothing. One way to have chiseled the subsidy cliff into a gentler slope would have been to keep some set of gradually declining premium subsidies for those earning over 400%. But when the staffers calculated the cost of extending the premium to people like the Smiths or the Johnsons, it was intolerably high.

Another way to chip at the cliff would have been to lower premium-subsidy percentages still more, beginning at the 300%-above-poverty level and gradually decreasing the subsidy to zero when 400% above poverty was reached. There would still be no payouts above 400%, but the declining slope of subsidies from 300% to 400% would have eliminated the cliff because those at 400% would be losing little by earning more. That would have pretty much evened up the fortunes of the Jones and Smith families. But as it is, the weakest part of the subsidy formula is that people who make three or four times the poverty level get subsidies that are arguably not enough to make their premiums affordable. In fact, the burden on those at the 300%-above-poverty level is another looming pothole in the details of the subsidy formula.

For example, even with their current $9,024 subsidy, the Johnsons in Florida, whose earnings are $62,040, are still paying about $5,000 a year in premiums (depending on the plan they choose). On top of that, they will also face a deductible and out-of-pocket costs of about $12,000. That means the Johnsons’ total medical costs (premium and amounts paid to meet the deductible) could take $17,000, or 27%, out of their $62,040 in pretax income. That’s better than the $26,000 it could cost them if they earn $63,000 and don’t get any subsidy. But it’s a stretch to call something that diverts 27% of a family’s pretax income the Affordable Care Act. After taxes, that’s probably about 50% of their disposable income.

Does all this mean Obamacare is going to backfire on its designers? Not necessarily. Only 1% or 2% of people signing up for the exchanges will fall off the cliff. They will mostly be older people, like the Johnsons, in expensive-health-care states, whose income is at or near 400% of the poverty level. Younger people, whom insurance companies charge lower rates, or people in lower-health-care-cost states, where all premiums are likely to be lower, probably won’t be affected much, if at all. But in a program that signed up 8 million people, that could still leave tens of thousands on the exchanges who will come close to or fall over a steep cliff. That’s a lot of families–and a lot of ammunition for the President’s opponents.

Complicating things, as a recent report in the Washington Post notes, is a little-known problem with the notorious (but mostly fixed) Obamacare website. The site’s system for verifying the incomes people have claimed in order to get subsidies is so gummed up that it may take months or years for the government to verify who deserves what subsidies. Many Obamacare patients will have to submit additional documents or face demands that their subsidies be returned to the IRS. That won’t be popular either. “I’m already advising some clients who may be at or near the cliff to watch their incomes toward the end of the year,” says Cohen. “Maybe they can stop working overtime or take a month off. If not, they could get hammered with huge tax bills that they never expected.”

Obamacare took a complex new law with complicated formulas involving big dollars moving in and out of peoples’ wallets and grafted it onto a health care system that was already impossible for most people to understand. In the most public-spirited age of bipartisan fellowship, that would not have been easy. So long as the Affordable Care Act is the Republicans’ favorite whipping boy, it’s likely to get just plain ugly.