Taxes and Health Care Bills - Considering Tax Policy

With the Senate passing health care legislation on December 24 and the House having done so on November 7, we now have 2 different health care bills that Congress will have to meld into a single bill. Each version has a variety of tax provisions. I'll note a few of them here with some analysis on how they stack up against principles of good tax policy.

First, the list of tax provisions and their cost or revenue effect can be found in Joint Committee on Taxation documents:

• JCX-53-09 - House bill H.R. 3962
• JCX-61-09 - Manager’s amendment to the revenue provisions in HR3590: Patient Protection and Affordable Care Act

Selected provisions of the House bill:

1. Impose an extra tax on individuals without acceptable health care coverage - well, the tax law can be used as both a carrot and a stick. This is an example of it being used as a stick. Neither approach is really ideal as the tax system should exist to raise revenue, not to modify behavior. But, if legislators believe there is no other way, it might be justified, particularly since the tax law already reaches almost all adults. This unfortunately makes the IRS the enforcer of health care law though, when it is supposed to be administering the tax law. Reporting on Form W-2 will indicate whether the individual has health care coverage from their employer. If they do not, this rule should require some type of documentation on the return to prove insurance coverage.
2. 5.4% surtax imposed on individuals with modified AGI in excess of $500K ($1 million in MFJ). This is expected to generate $460 billion of revenue over 10 years. What is the logic of having high income individuals (and uninsured (see above)) pay for health care reform? If Congress wants to raise taxes on high income individuals, it would be more transparent to just increase the top brackets in the rate schedule. For health care reform, I believe there is a better and more appropriate way to generate revenue and I have written about this before - tax a portion of the currently excluded health care benefits employees get from their employers. This step will also bring employees into the health care decision-making. They will be more likely to ask their employer why their health insurance costs so much, they will ask their doctor if they really need a particular procedure and why it costs so much. For more on this, see Pot of Gold in the Employer-Provided Healthcare Exclusion and 5/20/09 post.
3. Codify economic substance doctrine and increase Section 6662 penalties related to non-economic substance transactions - this proposal has been inserted into many bills over the years as a revenue raiser. I'm not convinced it will raise almost $6 billion over 10 years. But to clarify the existence of this doctrine, wording it in a way to apply to all taxpayers regardless of their litigation options and strategy, should make the tax law more transparent.

Selected provisions of Senate bill:

1. 40% excise tax on "Cadillac" health plans of employers. This is an ineffective way to tax high premium plans. It is not transparent because the tax is imposed on the "coverage provider" rather than the employee. It won't be clear who ultimately pays the tax (remember, business taxes are ultimately paid by employees, customers and investors/owners). It continues to leave employees out of too much of the health care decision-making. Also, if it has the effect of employers reducing coverage, it won't generate the intended revenue. An op ed in the Washington Post on 12/28/09 ("'Cadillac' tax isn't a tax -- it's a plan to finance real health reform," by Gruber) suggests that this excise tax is not a tax but "the elimination of an existing tax break that is provided to exactly these firms." This is not accurate. The tax break is to the employees, not the firms. Under our current system, employers deduct the cost of the health insurance they provide to employees and despite the fact that that benefit is "income" it is not taxable to the employees because of a tax rule that excludes it (it also is not subject to Social Security tax). Thus, the benefit is to the employees, not the employer (although the break does allow employers to offer generous health care benefits as a recruitment and retention perk). It would be more transparent and equitable to tax a portion of one's employer-provided health care benefits beyond a specific minimum amount (see earlier link to "pot of gold"). Also, there appears to be no requirement that the employer or insurance provider pass the excise tax along to the employee who has the "Cadillac" plan.
2. W-2 reporting of the health insurance perk employers provide to employees. This is a great idea because it enables employees to know how much their employer is paying for their health insurance coverage. It is also a good first step in then taxing some portion of this benefit which will make the income tax more equitable (the current exclusion provides a much greater benefit to those in high tax brackets).
3. Change the itemized deduction for medical expenses to a floor of 10% of AGI rather than the current 7.5% floor. Ten percent is the limit for AMT purposes. I'd rather see this change as part of a bill to repeal the AMT rather than help fund health care reform. In terms of most principles of good tax policy, the AMT is one of the worst features of our tax system (see Nellen, Simplicity and transparency versus the dread AMT, Silicon Valley/San Jose Business Journal, 12/7/07).
4. Raise the hospital insurance tax on wages and self-employment income in excess of $200,000 ($250,000 joint) by 0.9 percentage points - this would bring some progressivity to this tax and help fund Medicare which needs it. This will bring about some complexity for these individuals because if they have more than one source of earned income, their employer won't be able to calculate the entire tax (but not a significant amount of complexity). With reports of financial troubles with Medicare, it seems that a broader discussion and analysis of the revenue and spending design is needed.
5. 10% excise tax on tanning salons - seems odd and inappropriate to single out these businesses and their customers.

What do you think Congress should do with revenue provisions assuming they are able to get a single bill together?