Health Care Proposal for Broader Base and Higher Rate for Medicare Tax

The White House's health care plan includes a revenue provision to apply the Medicare (HI) tax of 2.9% (1.45% for each of employers and employees) to more than just wages and self-employment income. The HI tax for high income employees and self-employed would also be increased (but not the employer rate). Here is the White House explanation:

"Broadened Medicare Hospital Insurance (HI) Tax Base for High-Income Taxpayers Under current law, workers who earn a salary pay a flat tax of 1.45 percent of their wages to support the Medicare Hospital Insurance (HI) trust fund, but those who have substantial unearned income do not, raising issues of fairness. The Act will include an additional 0.9 percentage point Hospital Insurance tax for households with incomes exceeding $200,000 for singles and $250,000 for married couples filing jointly. In addition, it would add a 2.9 percent tax for such high-income households to unearned income including interest, dividends, annuities, royalties and rents (excluding income from active participation in S corporations)."

There are also other revenue proposals in the plan including codifying the economic substance doctrine and an excise tax on insurance companies on high costs health plans (starting in 2018).

But back to the Medicare tax broadening - is that a good idea? Well, something needs to happen with Medicare because it is facing shortfalls. The Social Security Administration in its annual actuarial reports notes this (see 2009 report here). Many young people joke about there not being any Social Security for them when they retire. While there are funding problems with Social Security, there are earlier and more severe ones with Medicare. Per the 2009 actuarial report, "Medicare's financial difficulties come sooner—and are much more severe—than those confronting Social Security." The report further notes:

"The projected 75-year actuarial deficit in the Hospital Insurance (HI) Trust Fund is now 3.88 percent of taxable payroll, up from 3.54 percent projected in last year's report. The fund again fails our test of short-range financial adequacy, as projected annual assets drop below projected annual expenditures within 10 years—by 2012. The fund also continues to fail our long range test of close actuarial balance by a wide margin. The projected date of HI Trust Fund exhaustion is 2017, two years earlier than in last year's report, when dedicated revenues would be sufficient to pay 81 percent of HI costs. Projected HI dedicated revenues fall short of outlays by rapidly increasing margins in all future years. The Medicare Report shows that the HI Trust Fund could be brought into actuarial balance over the next 75 years by changes equivalent to an immediate 134 percent increase in the payroll tax (from a rate of 2.9 percent to 6.78 percent), or an immediate 53 percent reduction in program outlays, or some combination of the two. Larger changes would be required to make the program solvent beyond the 75-year horizon."

An almost 7% rate for HI tax (3.5% each for employee and employer and 7% for self-employed) is steep on top of Social Security taxes of 6.2% for employer and employee and 12.4% for self-employed and income taxes! Perhaps the White House proposal to also have high income individuals with unearned income contribute to Medicare will help (and some of these individuals will get Medicare benefits without paying the tax on earnings).

It would be nice to see the figures on whether the proposed increase and expansion for the HI tax addresses the funding problem AND what cost savings will be put in place to also address the problem and keep it from continuing to worsen.

So, a change in the HI revenue model is certainly needed, but we should also see cost savings proposals too. The White House HI proposal does make the tax more equitable in bringing some progressivity to it and having it apply to not only wages, but to unearned income (of high income individuals). I don't know why it was just a payroll tax unless the model of many years ago showed that such a tax would be sufficient.

Transparency is a problem in that most workers probably could not tell you what percent of their wages is used to pay the HI tax and I'd guess that many workers don't even know about the tax. With the broadened base, we should ask why not just increase the income tax rates. I think that is the transparency dodge - the rate increase will be less noticed as an HI tax than a higher income tax rate.

What do you think?