Tax Implications of Health Care Reform

Health care reform has been a hot topic as of late in Washington, DC. Most of the debate has focused on how to pay for it. With the federal government already having spent record sums to bailout financial firms and the auto industry, and having borrowed even more to help spark the economy through a stimulus, Congress and Obama administration realizes that they have to find a new revenue source to finance the initial transition.

What complicates this even more is some campaign promises—and implied promises—that Democrats and President Obama made during the campaign leading up to last November’s election. Prominent among these promises are the following:

* Must provide coverage to at least 95% of Americans
* Transition must cost ~$1 trillion or less over 10 years
* Transition must be financed through an identified stream of revenue
* Must not raise taxes on those earning less than $250,000 per year

Given the above, Congressional leaders and the Obama Administration have been limited in what they can and cannot do, or run the risk of creating a new “read my lips” moment with voters.

Notwithstanding the above, there are some particular tax changes and increases that are being seriously considered. Please see below for more information. Moreover, let me know your thoughts, by posting them here on my Twitter account.

Limit Income-Tax Deductions

By only allowing taxpayers in the top two income tax brackets (33% and 35%) to deduct their mortgage interest, charitable contributions, and local taxes at the 28% rate it is suggested that the Federal government could collect $267 billion over the next 10 years. This is supposedly one of the Obama administrations main tactics for raising revenue. However, numerous Democratic leaders have already spoken out against it claiming it would hurt charities and residents of highly taxed areas such as New York City. Although experts predict that the original proposal will likely not pass into law, they are suggesting that some type of watered down version will.

Taxing Employer Provided Benefits

With the support of both Republicans and moderate Democrats in Congress—and even the most influential members of the Senate Finance Committee—the concept of taxing employer provided health benefits is something that has been getting a lot of attention lately. Although House Speaker Nancy Pelosi adamantly opposed any legislation regarding the issue, there are number of recent compromises that have made the new tax more likely to become law. The compromises include capping the value of benefits that go untaxed (for example if the tax-free limit is $13,000, an employee with a policy worth $15,000 would pay income taxes on $2,000), and imposing an income tax surcharge on the wealthiest taxpayers.

Tax Surcharge on the Wealthy

Speaking of tax surcharges on the wealthy, increasing the tax rate on taxpayers with incomes of over $200,000 or couples earning over $250,000 has also been discussed as a way to help pay for health care reform. This is the hot proposal in the House. Current proposals would levy an additional 3-4%, with the possibility of an additional 0.6% tax on those making more than $500,000. It is projected that if passed these tax increases would generate an estimated $832 billion in Federal revenue over the next decade. Unfortunately, these increases would be on top of Obama’s plan to let the “Bush Tax Cuts” expire, which would already increase the top tax rate to 39.6%. Therefore, it would put the combined state and Federal tax rates of some Americans at 51%, which is higher than many European countries including France and Germany. Although this plan has zero support from Republicans in Congress (the Obama administration has yet to support it either), it is favored by many Democrats and could pass with their filibuster proof majority.

Increased “Sin Taxes”

As I mentioned in an entry earlier this month titled 10 Ways the Federal Government May Try to Collect More Money -- From You, increased taxes on sugar heavy soft drinks, tobacco products, and alcoholic beverages (also known as sin taxes) could provide up to $200 billion in additional tax revenue over the next 10 years. According to reports taxes on alcohol were last raised in 1991, and adjusted for inflation they are actually 37% lower today. However, with little support and opposition for dozens of industries, any such increases are very likely to ever see the light of day.

Repeal of Tax Saving Accounts and Deductions

Although not a direct tax increase, by repealing tax-advantaged savings accounts for health expenses, and repealing the medical expense deduction the Federal government could save over $250 billion. However, these taxes would mostly affect senior citizens already struggling with huge medical bills, and would directly break Obama’s pledge to not increase taxes on families making under $250,000.

Shared Responsibility Payments

Although it may sound confusing, shared responsibility payments are basically fines for not having insurance. By requiring Americans to have some sort of coverage—similar to how motorists must get auto insurance—and enforcing a $1,000 per year fine, the Federal government could collect over $36 billion over the next decade. It would likely include subsidies for lower income Americans, and the concept has gotten support from a number of key Senate Democrats.

Expanded Medicare Taxes

One of the final taxes being considered to help pay for health care reform is an expansion of the Medicare tax. Currently the tax is only levied on earned income (wages from your employer, etc.). By levying the tax on capital gains, dividends and other unearned income, and increasing the rate for high-income earners, the government could collect over $500 billion over the next year. However, raising taxes on unearned income is highly unpopular among the American public, and under the current proposal 80% of the tax increase would be paid for by the top 5% of taxpayers.