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March 22, 2010

Economics Group

Special Commentary

John Silvia, Chief Economist


john.silvia@wellsfargo.com ! 704-374-7034
Mark Vitner, Senior Economist
mark.vitner@wellsfargo.com ! 704-383-5635

A Few Brief Comments on Healthcare Reform


The financial markets appeared to have already priced in passage of the healthcare bill before the
weekend. There also appears to be some sense of relief the long and arduous process is coming to
an end. Our early assessment is that, while there is a great deal of cost shifting taking place, the
Unfortunately, the
bill that passed was less onerous than many had feared. Unfortunately, the history of massive
history of massive
social spending programs is that they tend to grow larger and larger over time. Moreover, the
social spending
scoring by the Congressional Budget Office (CBO), which shows the program costing $940 billion
programs is that
and reducing the deficit $138 billion over the 2010 to 2019 period, was based on a strict
they tend to grow
interpretation of the bill as it was written. The costs will likely be higher than the CBO estimate
larger and larger
and the budget deficit will also likely be larger. Savings from Medicare cutbacks are likely to be
over time.
harder to achieve than the plan suggests. Moreover, the extended phase-in of the program will
likely lead to incessant political pressure to expand benefits and scale back the tax hikes.
The passage of the healthcare bill will have relatively little impact on economic conditions over
the near term. Presuming the bill is signed into law following a few more procedural votes, most
of the provisions of the new law will not take effect for a couple of years.
Some of the earliest changes include tax credits for small businesses to encourage them to provide
healthcare coverage to their employees and new laws and rules prohibiting insurance companies
from denying coverage to children with preexisting illnesses. Both take effect this year. The widely
touted insurance exchanges, where people without employer-sponsored insurance coverage and
small businesses can shop for health coverage, take effect in 2014. That same year is when most
people will be required to have health insurance and is also when the Medicaid program will be
expanded to include all Americans with incomes up to 133 percent of the poverty level.
Taxes will increase sooner, beginning with a new 10 percent surtax on indoor tanning salons this
July. Drug companies will start paying higher taxes beginning in 2011 and higher income
households will face higher taxes in 2013. The Medicare payroll tax will increase from
1.45 percent currently to 2.35 percent in 2013 and a new 3.8 percent tax on unearned income will
also take affect that year on households. Both taxes will hit individuals earning $200,000 and
above and couples earning $250,000 or more. In addition, a new excise tax of 2.3 percent will be
imposed on sales of medical devices such as pacemakers and hip replacements.
The primary drivers for passing healthcare reform were to increase the proportion of the
population covered by some sort of healthcare insurance and hold down the rate of growth in
healthcare expenses. The new healthcare law appears to accomplish much of the first objective,
although it is unclear how many firms will choose to pay a fine as opposed to offer coverage to
their employees. Employers with 50 or more employees will be required to provide affordable
healthcare coverage to their employees or pay a $3,000 per employee fine. The rule takes affect
in 2015 and also excludes the first 30 workers from the fine. Part-time workers would be covered
by the law on a pro-rated, or full-time equivalent, basis.
There is little evidence the new healthcare law will hold down the price of healthcare. Healthcare
costs have been rising faster than the overall inflation rate for about as long as can be

This report is available on wellsfargo.com/research and on Bloomberg WFEC


A Few Brief Comments on Healthcare Reform WELLS FARGO SECURITIES, LLC
March 22, 2010 ECONOMICS GROUP

remembered. The driving force for this increase has been the aging of the population, which has
resulted in increased demand of healthcare services and a lack of market discipline in the
Relatively few healthcare marketplace. Relatively few people pay the full costs of medical care when they visit
people pay the full the doctor or purchase pharmaceuticals. Most costs are paid indirectly either by insurance
costs of medical companies or the government. This leads to over consumption and little to no price sensitivity.
care when they The cost of insurance and government programs are then paid for by consumers and businesses.
visit the doctor or The cost of purchasing insurance should be reduced by the creation of exchanges, where small
purchase businesses and individuals would be able to pull their purchasing power. It is unclear how the
pharmaceuticals. new healthcare law will reduce actual healthcare costs, however, particularly as it will increase the
number of people covered by insurance and likely result in increased demand for healthcare
services. In addition, much of the cost of healthcare services and products are real and cannot be
wished away. Creating life-saving drugs and providing high-level services comes with a price.
Rather than reducing costs, the healthcare plan appears to shift costs to employers and higher-
income households. Larger employers, particularly retailers, would face higher healthcare costs
or wind up paying significant fines. Smaller retailers and smaller employers in general, would
fare better as they would more likely fall under the 30-worker exclusion provision. The higher
taxes on investment earnings for individuals earning $200,000 or more and households earning
$250,000 or more would be on top of the expected increase in tax rates following the expiration
of the lower tax rates on dividends and capital gains at the end of this year. The higher tax rates
on investment earnings will draw more investment dollars into tax avoidance projects and lead to
modestly lower investment throughout the economy. Likewise, the new tax on medical devices
and pharmaceutical companies will modestly reduce profitability of these firms and increase their
cost of capital. This could lead to less innovation and product development.
Figure 1

U.S. CPI - Medical Care


Series are 3-Month Moving Averages
15% 15%
Medical Care 3-M Annual Rate: Feb @ 3.7%
Medical Care Yr/Yr Pct Chg: Feb @ 3.5%
Core CPI Year-over-Year Percent Change: Feb @ 1.5%
12% 12%

9% 9%

6% 6%

3% 3%

0% 0%
80 83 86 89 92 95 98 01 04 07 10

Source: U.S. Department of Labor and Wells Fargo Securities, LLC

2
Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg Global Head of Research (704) 715-8437 diane.schumaker@wellsfargo.com


& Economics (212) 214-5070

John E. Silvia, Ph.D. Chief Economist (704) 374-7034 john.silvia@wellsfargo.com


Mark Vitner Senior Economist (704) 383-5635 mark.vitner@wellsfargo.com
Jay Bryson, Ph.D. Global Economist (704) 383-3518 jay.bryson@wellsfargo.com
Scott Anderson, Ph.D. Senior Economist (612) 667-9281 scott.a.anderson@wellsfargo.com
Eugenio Aleman, Ph.D. Senior Economist (612) 667-0168 eugenio.j.aleman@wellsfargo.com
Sam Bullard Economist (704) 383-7372 sam.bullard@wellsfargo.com
Anika Khan Economist (704) 715-0575 anika.khan@wellsfargo.com
Azhar Iqbal Econometrician (704) 383-6805 azhar.iqbal@wellsfargo.com
Adam G. York Economist (704) 715-9660 adam.york@wellsfargo.com
Ed Kashmarek Economist (612) 667-0479 ed.kashmarek@wellsfargo.com
Tim Quinlan Economic Analyst (704) 374-4407 tim.quinlan@wellsfargo.com
Kim Whelan Economic Analyst (704) 715-8457 kim.whelan@wellsfargo.com
Yasmine Kamaruddin Economic Analyst (704) 374-2992 yasmine.kamaruddin@wellsfargo.com

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