Congress May Close a Gap in the Medicare Tax to Help Fund Health Care Reform



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In May of last year, Citizens for Tax Justice proposed several progressive options to raise revenue to finance health care reform. Our favorite idea was to close a gap in the one big tax for health care that we already have, the Medicare payroll tax. The Medicare payroll tax is a 2.9 percent tax on earnings, half of which is nominally paid by employers while the other half is nominally paid by workers. (Economists agree that workers ultimately pay the employer half as well, in the form of reduced wages or benefits.) We noted that this existing tax for health care completely exempts people who live off of investment income.

Imagine someone who does not have to work because he or she collects capital gains, stock dividends, interest, rents, royalties, S corporation income or some other type of investment income. This individual does not have to pay any payroll tax (Medicare tax or Social Security tax) on this income. Eligibility for Medicare is still possible upon reaching age 65 as long as he or she worked (and thus paid the Medicare payroll tax on earnings) for about ten years at some point in the past.

By the time she reaches age 65, even Paris Hilton may have appeared on television and in other venues enough to have worked a full ten years (and thus be eligible for Medicare). But something tells us that there will be a whole lot of years when she did not work and didn't have to pay a cent towards Medicare.

CTJ's Proposal to Reform the Medicare Tax

Our initial proposal was to make the individual portion of the Medicare tax (the 1.45 percent nominally paid by workers) apply to investment income as well as wages, and then introduce a second, higher rate for singles with income over $200,000 and couples with income over $250,000. In other words, the Medicare tax would become a health care tax that would apply to all income, and the portion paid by individuals would have two rates, 1.45 percent and 2.5 percent. Employers would still only pay 1.45 percent on earnings of their employees. And we also proposed an exemption of $50,000 for seniors ($100,000 for married seniors).

CTJ worked for several months with a broad coalition of policy advocates, think-tanks, faith-based groups and labor unions to bring progressive financing options like this to the attention of members of Congress. State-based groups released reports with state-specific figures while national organizations educated lawmakers about progressive financing options and dispelled the myths that were manufactured to block any increase in revenues.

Lawmakers Seek Medicare Tax Reform

Some version of the Medicare tax reform proposal might end up in the final health care reform legislation.

As lawmakers became interested in different variations of this proposal, we analyzed several versions of it, one of which was included in an amendment filed by Senator Debbie Stabenow (D-MI) during a committee markup. The provision that eventually becomes law might be similar to our original proposal. The health care bill approved by the Senate on Christmas Eve included a provision to increase the individual portion of the Medicare payroll tax on earnings from 1.45 percent to 2.35 percent for those above the $200,000/$250,000 threshold. This was estimated to raise about $87 billion over the first ten years after enactment.

Now there is talk that the final bill might include that and also apply the individual portion of the Medicare tax (apparently at a rate of 2.35 percent) to investment income for those taxpayers above the $200,000/$250,000 threshold. The current incarnation entirely exempts all pension income and Social Security benefits.

One tax expert mistakenly told the LA Times that this proposal "could hit some of the elderly who are relying on savings to get by." If the expansion of the Medicare tax only applies (as seems likely) to incomes over $200,000 for singles and $250,000 for married couples, we would hardly call that a tax increase on people who are just "getting by." Only around 2.1 percent of all taxpayers will have adjusted gross income (AGI) above that threshold next year.

What Congress Might Do with the Revenue

The additional revenue that results from extending the Medicare tax to investment income could be used to address two complaints that many Democrats in the House have about the bill approved by the Senate. The first is that the Senate bill's subsidies are not sufficient to make health care affordable for low-income people, as explained in a recent report from the Center on Budget and Policy Priorities.

The second complaint against the Senate bill is that it relies too much on an excise tax on health insurance companies offering high-cost benefit plans. As explained in a report from CTJ, this excise tax is not particularly progressive. Health insurance plans are often high-cost just because a company's workforce is older, more female, or engaged in a riskier activity like mining.

The best case scenario is that many people, including a lot of middle-income people, who currently have high-cost plans will see a portion of those health benefits replaced by wages. That's not as good a deal as you might think, since wages are subject to both the income tax and the payroll tax, while health care benefits are currently tax-free.

And the usual criticism of tax deductions -- that they are worth more to a rich person in the 35 percent bracket than a middle-class person in the 25 percent bracket -- does not apply as much in this case. As the CTJ report explains, if tax-free compensation (like employer-provided health care) is turned into taxable income, rich folks get a break on one of the taxes that would otherwise apply. Taxable earnings are subject to the income tax, the Medicare payroll tax and the Social Security payroll tax, but for the last one there's a limit on how much wages are subject to it.

As of this writing, Congressional leaders are trying to finish up lengthy talks with the President at the White House, and there seems to be an agreement to limit the excise tax on high-cost health insurance plans.

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