Health Insurance and Wages: Compensating Differentials in Reverse?

One of the oldest theories in economics is the idea of compensating differentials. A job represents not just a certain amount of money per hour, but a whole package of positive and negative things. Jobs have more or less stability, flexibility, fun, room to grow, danger… and non-cash benefits like health insurance. The idea of compensating differentials is that, all else equal, jobs that are good on these other margins can pay lower cash wages and still attract workers (thus, the danger of doing what you love). On the other hand, jobs that are bad on these other margins need high wages if they want to hire anyone (thus, the deadliest catch)

I think this theory makes perfect sense, and we see evidence for it in many places. But when it comes to health insurance, everything looks backwards. A job that offers employer-provided health insurance is better to most employees than one that doesn’t, so by compensating differentials it should be able to offer lower wages. There’s just one problem: US data shows that jobs offering health insurance also offer significantly higher wages. The 2018 Current Population Survey shows that workers with employer-provided health insurance had average wages of $33/hr, compared to $24/hr for those without employer insurance.

All the economists are thinking now: that’s not a problem, compensating differentials is an “all else equal” claim, but not all else is equal here. The jobs with health insurance pay higher wages because they are trying to attract higher-skilled workers than the jobs that don’t offer insurance.

That’s what I thought too. It is true that jobs with insurance hire quite different workers on average:

Source: 2017 CPS analyzed here

The problem is, once we control for all the observable ways that insured workers differ, we still find that their wages are significantly higher than workers who don’t get employer-provided insurance. Like, 10-20% higher. That’s after controlling for: year, sex, education, age, race, marital status, state of residence, health, union membership, firm size, whether the firm offers a pension, whether the employee is paid hourly, and usual hours worked. I’ve thrown in every possibly-relevant control variable I can think of and employer-provided health insurance always still predicts significantly higher wages. Of course, there are limits to what we get to observe about people using surveys; I don’t get any direct measures of worker productivity. Possibly the workers who get insurance are more skilled in ways I don’t observe.

We can try to account for these unobserved differences by following the same person from one job to another. When someone switches jobs, they could have health insurance in both jobs, neither, only the new, or only the old. What happens to the wages of people in each of these situations? It turns out that gaining health insurance in a new job on average brings the biggest increase in wages:

What could be going on here? One possibility is that health insurance makes people healthier, which improves their productivity, which improves their wages. But we control for health status and still find this effect. The real mystery is that papers that study mandatory expansions of health insurance (like the ACA employer mandate and prior state-level mandates) tend to find that they lower wages. Why would employer-provided health insurance lower wages when it is broadly mandated, but raise wages for individuals who choose to switch to a job that offers it?

My current theory is that “efficiency benefits” are offered alongside “efficiency wages”. The idea of efficiency wages is that some firms pay above-market wages as a way of reducing turnover. Workers won’t want to leave if they know their current job pays above-market, and so the company saves money on hiring and training. But this only works if other firms aren’t doing it. The positive correlation of wages and insurance could be because the same firms that pay “efficiency wages” are more likely to pay “efficiency benefits”- offering unusually good benefits as a way to hold on to employees.

I still feel like these results are puzzling and that I haven’t fully solved the puzzle. This post summarizes a currently-unpublished paper that Anna Chorniy and I have been working on for a long time and that I’ll be presenting at WVU tomorrow. We welcome comments that could help solve this puzzle either on the empirical side (“just control for X”) or the theoretical side (“compensating differentials are being overwhelmed here by X”).

8 thoughts on “Health Insurance and Wages: Compensating Differentials in Reverse?

  1. Shishir Shakya April 27, 2023 / 11:48 am

    How about people at the margin of income threshold to qualify for Medicaid? These people won’t work more hours otherwise they will be disqualify for Medicaid. So there must be a larger bump in the income to let go Medicaid and choose a private health insurance. But this only works for people with lower income and their incentives.


  2. Victoria Wilson April 27, 2023 / 12:16 pm

    Perhaps higher-wage jobs are more likely to be filled by primary breadwinner/one-wage-earner families. Hence a greater need to cover the dependents?

    Liked by 1 person

  3. David Abell April 27, 2023 / 6:26 pm

    I enjoy your economic topics greatly!

    Could employers feel incentivized to increase wages to cover the new employee’s expense on healthcare premiums? Although overall health expenses will presumably decrease for the employee once on insurance, the employee may be short sighted and demand compensation for the immediate decrease in post benefit deduction pay.


  4. Zachary Bartsch April 28, 2023 / 7:28 am

    1) I agree with Victoria above. Higher earners have different compensation preferences.

    2) But also, let’s get Coasian/Yellenian. We observe efficiency wages when there is a higher cost of turnover. For low skill jobs, the cost of training is relatively low. Maybe check the turnover difference between higher and lower compensations.

    3a) Also, do large companies tend to provide health insurance and pay more (than smaller companies)? What do large companies have? They have scale and bargaining power with the insurance market.

    3b) With more employees, they can spread the fixed costs of insurance administration across more employees.


  5. yjtan April 28, 2023 / 12:49 pm

    Could it not be a matter of taxes? In my mind I’m thinking of it as going in the other direction – “we want to give you wage X, but it isn’t tax bracket efficient for you, so we’ll give you wage Y and expand healthcare benefits instead.”

    In that vein, it wouldn’t be benefits predicting wages; it’d be wages predicting benefits.


    • Zachary Bartsch April 28, 2023 / 1:43 pm

      That’s great! Increasing (progressive) marginal income tax rates make insurance more tax efficient for the higher earning employee. By this logic, states with flat or zero income taxes should exhibit a weaker relationship between income and insurance.


      • yjtank April 28, 2023 / 1:49 pm

        Yeah, I’m not sure how one would instrumentalise that, the tax schedule and its multitude of carve-outs being what it is. But I would imagine that then Nevada, Alaska, Wyoming, Florida, Texas…health insurance coverage (among employed) would be less deep.

        (Apologies for the double-commenting! Some kind of WP hiccup?)


  6. yjtank April 28, 2023 / 12:50 pm

    Could it not be a matter of taxes? In my mind I’m thinking of it as going in the other direction – “we want to give you wage X, but it isn’t tax bracket efficient for you, so we’ll give you wage Y and expand healthcare benefits instead.”

    In that vein, it wouldn’t be benefits predicting wages; it’d be wages predicting benefits.


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