While the nation’s unemployment rate continues to linger around 10%, Congress will soon return to Washington to devise a way to get a health care bill passed by both the House and Senate. As the negotiations loom, a recent paper by Heritage’s John Ligon explores the devastating effects that the employer mandate in the House health care bill would have for small business.

In order to pressure more businesses into providing health care for their employees, the House bill includes an incremental payroll tax on employers that fail to do so. This tax starts at 2% for employers with total annual payroll of $500,000 and increases to 8% on total annual payroll of $750,000 or more. This tax would affect all employers, even those with 25 employees or fewer, since it is based on total payroll, not number of employees.

This tax will add significantly to small business expenditures, regardless of whether they choose to offer health benefits to their employees or not. According to the bill, if employers do offer benefits, they cannot come out of employee’s wages, and they must meet the federal requirements concerning covered benefits. If they choose not to add health care to their expenses, small businesses will instead pay the tax.

However, the structure of the tax causes it to go further than acting simply as an incentive to offer health benefits to employees. Ligon writes: “the employer mandate structure in the House-passed health care bill would create a strong disincentive for a business to expand compensation or even acquire new workers.” This is because, as a business nears a higher payroll bracket, it also risks spending a much higher percentage of its earnings to pay the penalty tax. For example, an employer with total payroll of $499,999 would have paying a $10,000 penalty if it increased its payroll just one dollar. Undoubtedly, this would cause any small business owner to reconsider before offering bonuses or wage increases to its workers.

In the Senate bill, employers with 25 workers or fewer are exempt from paying a penalty for not offering health care to its employees. Not only does the House bill eliminate this exemption, but it also penalizes small business such that employers with 25 workers or less could end up paying the full 8% payroll tax. Ligon estimates that as many as 68,288 small businesses could fall in the highest marginal penalty range (8%).

Businesses affected by this tax would clearly react to its ramifications, especially during a period of economic downturn. Those who could not afford to offer health benefits or pay the higher tax would look for other ways to outmaneuver the government. This would most effectively be done by containing or reducing wages, and failing to hire additional workers. With an unemployment rate stagnating at 10%, this is the opposite direction in which Congress should be sending small business.