How the Affordable Care Act Will Reduce Small Business Employment

affordable care act will reduce

The Congressional Budget Office (CBO) reported last week that the Affordable Care Act (ACA) will mean that two million fewer people will be employed full-time in 2017 than would be working in the absence of the law.

Unmentioned in the report, or the firestorm of commentary that followed, was how the reduction in employment would be distributed between big and small companies. The employment decline will occur almost completely in the small business sector.

In fact, the new health care law will accelerate a two-decade long erosion in the share of Americans employed in small companies. My back-of-the-envelope calculations suggest that the ACA’s effect will combine with the current trend to result in only 46.4 percent of private sector workers being employed in small businesses in 2017.

That’s a major shift from the 54.5 percent who worked in small companies back in 1988.

So How Will the ACA Reduce Small Business Employment?

The ACA will accelerate the decline in small business employment by reducing both the willingness of small business workers to supply labor – and the willingness of small business owners to demand it.

On the supply side, the income-based phase out of subsidies to buy insurance on the new health insurance exchanges will reduce the willingness of people to work. Starting this year, low-income Americans who buy insurance through the new exchanges are eligible for subsidies to offset the cost. Because those subsidies decline as income rises, they raise people’s marginal tax rates and reduce their willingness to work.

The ACA-induced decline in the labor supply will be concentrated in the small business sector because the subsidies apply only to workers who do not receive employer-sponsored health insurance.

The Kaiser Family Foundation reports that 99 percent of businesses with 200 or more workers provide employee health insurance, while only 57 percent of businesses with between 3 and 199 workers do. Therefore, the workers who will become unwilling to supply labor as they lose their health insurance subsidies will be those who work at businesses that don’t provide employee health coverage, almost all of which are small.

The penalty on employers with at least 50 full-time employees who fail to provide health insurance to their workers, scheduled to start in 2015, also will reduce the supply of labor to small businesses. The CBO, and many academic economists, believe that cost of this penalty ultimately will be passed on to workers through reduced compensation. Lower wages, in turn, will reduce workers supply of labor because people’s willingness to give up leisure time depends on what they earn.

Because only those businesses that do not offer employee health insurance will face the new penalty, and because almost all large businesses provide employee health coverage, the effect of the penalty on employee compensation and the subsequent willingness of workers to supply labor will be concentrated among those small businesses that do not provide employee health care coverage.

The penalty for not providing employee health insurance will also lower small business owners’ demand for labor, the CBO notes. Businesses can avoid triggering this penalty by keeping their labor force below 50 full-time workers. Therefore, the CBO expects some small businesses to restrain their hiring or to convert full-time positions into part time ones to remain below the threshold.

The CBO obliquely mentions that the negative employment effects of the ACA:

“. . .will be most evident in some segments of the workforce and will be small or negligible for most categories of workers.”

For those of us interested in small business, it’s unfortunate to see that the negative effects will be greatest for those people working in small companies.

ACA Photo via Shutterstock

Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.