Market Inefficiency, Insurance Mandate and Welfare: U.S. Health Care Reform 2010

In this paper we develop a stochastic dynamic general equilibrium overlapping generations (OLG) model with endogenous health capital to study the macroeconomic effects of the Affordable Care Act of March 2010 also known as the Obama health care reform. We find that the insurance mandate enforced with fines and premium subsidies successfully reduces adverse selection in private health insurance markets and subsequently leads to almost universal coverage of the working age population. On other hand, spending on health care services increases by almost 6 percent due to moral hazard of the newly insured. Notably, this increase in health spending is partly financed by the larger pool of insured individuals and by government spending. In order to finance the subsidies the government needs to either introduce a 2.7 percent payroll tax on individuals with incomes over $200,000, increase the consumption tax rate by about 1.1 percent, or cut government spending about 1 percent of GDP. A stable outcome across all simulated policies is that the reform triggers increases in health capital, decreases in labor supply, and decreases in the capital stock due to crowding out effects and tax distortions. As a consequence steady state output decreases by up to 2 percent. Overall, we find that the reform is socially beneficial as welfare gains are observed for most generations along the transition path to the new long run equilibrium.