The health law establishes insurance exchanges—regulated marketplaces in which individuals and small businesses can shop for coverage—and minimum standards for the insurance policies that can be offered. Because the policies will be so costly, there's a subsidy for buyers that phases out as family income rises. This sounds reasonable—but the subsidies required to make a "qualifying" insurance policy affordable are so large that their phaseout creates chaos.
Starting in 2014, subsidies will be available to families with incomes between 134% and 400% of the federal poverty line. For example, a family of four headed by a 55-year-old earning $31,389 in 2014 dollars (134% of the federal poverty line) in a high-cost area will get a subsidy of $22,740. A similar family earning $93,699 (400% of poverty) gets a subsidy of $14,799. But a family earning $1 more—$93,700—gets no subsidy.
Consider a wife in a family with $90,000 in income. If she were to earn an additional $3,700, her family would lose the insurance subsidy and be more than $10,000 poorer.
To phase out the subsidy smoothly for families with incomes of 134% to 400% of poverty, the law would have to take away $22,700 in subsidies as a family's income rose to $93,700 from $31,389. In other words, for every dollar earned in this income range, a family's subsidy would have to decline by 36 cents. On top of 25% federal income taxes, 5% state income taxes, and 15% Social Security taxes, this implies a reward to work of less than 20 cents on the dollar—in economists' language, an implicit marginal tax rate of over 80%.
In other words, the existence of sizable subsidies would create extremely high marginal tax rates for a large number of people. Many families could find themselves in a situation where working more or getting a pay raise would actually (and significantly) reduce their take-home pay. This would be not only damaging to the economy and our living standards, but unacceptable from the point of view of simple logic and basic notions of fairness. It's a trap, not a subsidy. Memo to starry-eyed liberals: subsidies may sound like a great way to redistribute income, but they bring with them a host of unintended, perverse, and outrageous consequences.