The college wage premium—the difference earned by people with and without a college degree—has grown substantially in recent decades. In 1977, college graduates in the United States earned on average 47 percent more than those without college degrees. By 2019, the premium had increased to 90 percent.
Theories abound to explain the widening gap: globalization, a stagnant minimum wage, the decline of unions, and the rise of robots. A less obvious contributor may be the distinctly American tether between health benefits and employment, according to MIT’s Amy Finkelstein, Princeton PhD student Casey McQuillan, Princeton’s Owen Zidar, and Chicago Booth’s Eric Zwick.
Virtually every US resident with private health benefits receives them through an employer. The federal government heavily subsidizes this arrangement by letting employers write off the costs, reducing federal tax revenue by $300 billion a year—the single-largest federal tax expenditure.
Because the costs of these benefits are not contingent on earnings, the burden is proportionally heavier for workers who make less money. In 2019, the average annual cost of employer-provided health benefits—$12,000—amounted to 25 percent of the income of an average full-time worker without a college degree, compared with 12 percent of the earnings of a full-time worker with a degree.
The researchers quantified the historical effect of this health wedge, as they call it, on employment and earnings. They find that the burden of surging medical costs over the past several decades has contributed roughly as much to inequality in the labor market as far more prominent concerns such as globalization.
To understand the importance of the health wedge in today’s world, Finkelstein, McQuillan, Zidar, and Zwick built a model of two parallel, hypothetical worlds. In one, they tested what would have happened since 1977 if health benefits had been financed through a progressive payroll tax, where higher earners paid more. In the other, they tested what would have happened if US healthcare costs had risen more slowly, as in other countries.
In the first scenario, where the cost of health benefits was linked to earnings, “labor market outcomes would have evolved quite differently,” the researchers write. People without a college degree would have 500,000 more jobs available to them now, and the employment gap between those with and without degrees would be 20 percent smaller. The wage premium for a degree would be about 11 percent smaller. To achieve the same outcome today by raising the minimum wage, policy makers would have to jack it up by 30 percent, the researchers calculate.
In the second scenario, the researchers analyzed the effects on the labor market had healthcare costs held steady at the 1977 rate of almost 8 percent of GDP, rather than soaring to 17 percent of GDP by 2019. They find that the wage premium for a college degree would be about 11 percent lower, and pay for those without a college degree would be about 12 percent higher, or $6,000 more a year. If American medical outlays had risen even a bit more slowly, for example, matching Canada’s current 11 percent of GDP, the premium for a degree would be 5 percent lower, and earnings for those without a degree, 5 percent higher, they find.
The researchers take pains to highlight the magnitude of this effect and how it interacts with other prominent stories of the labor market’s evolution. The growth of international trade and other labor-market changes might be partly driven by health costs, they suggest. A company might outsource jobs because medical benefits for domestic workers are too expensive.
In his 2023 State of the Union address, President Joe Biden suggested that we “offer every American a path to a good career, whether they go to college or not.” One avenue for doing so might be to reexamine the current system of employer-based medical benefits.
“The uniquely American approach to financing health insurance could have a quantitatively important impact on labor market inequality,” the researchers write. “Our analysis suggests that if the cost of health care in the United States continues its rapid rise over the coming years, labor market inequality will also continue to grow in the absence of substantial reforms to how we finance health insurance.”
Amy Finkelstein, Casey McQuillan, Owen Zidar, and Eric Zwick, “The Health Wedge and Labor Market Inequality,” Working paper, April 2023.
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