On Wednesday night, Senate Majority Leader Harry Reid (D-NV) released his health care bill, which is a combination of the health bills approved by the Senate Finance Committee and the Senate Health, Education Labor and Pensions (HELP) Committee. The excise tax on high-cost insurance plans is scaled back a bit from the version included in the Finance bill, probably because Senator Reid heard from health experts and unions who pointed out that plans have high costs sometimes simply because they serve an older workforce or a workforce with more health risks.
One revenue-raising provision that Reid included that had not been in any health bill so far is his proposal to increase the Medicare payroll tax rate (from 1.45 percent to 1.95 percent) for those earning over $200,000, or over $250,000 for married couples. This provision may be inspired by a proposal Citizens for Tax Justice made in May to reform the Medicare tax. CTJ joined forces over the summer with dozens of non-profits, faith-based groups, unions and other members of a coalition called Rebuild and Renew America Now (RRAN) to promote this and other progressive revenue options to help finance health care reform.
But CTJ's proposal would reform the Medicare tax by raising the rate for those with adjusted gross income above $200,000/$250,000 and by expanding the tax so that it applies to investment income as well as wages. The second part of that proposal -- changing the Medicare tax so that it no longer exempts investment income -- is the more significant reform of the two, and we hope it will be added to the health bill as a floor amendment.
To understand why the Medicare tax should apply to investment income, it helps to remember that there are some Americans, most of whom are extremely wealthy, who live entirely off of their investments. A person who lives off his or her investments pays no Medicare taxes. But they can still be eligible for Medicare benefits as long as they worked about ten years (usually) and thus paid Medicare taxes during that time.
Almost all Americans have collected a paycheck for at least ten years before they retire, but some are lucky enough to drop out of the workforce before retirement and collect stock dividends, capital gains, interest and profits from businesses they own a stake in. It's likely that even Paris Hilton will do enough television work and other types of work to become eligible for Medicare -- but she could also spend a whole lot of years not working and not paying the Medicare tax.
Some economists have pointed out that increasing the Medicare tax on wages alone, as Senator Reid proposes, is a problematic idea because it encourages the wealthy to find ways to convert their work income into investment income. This fear may be a little overblown, since Reid's proposal is a mere 0.5 percent tax increase on wages. And the methods that can be used to convert wages into investment income are somewhat limited. (Compensation in the form of stock or stock options is already subject to the Medicare tax, for example.)
But it's true that Senator Reid's proposal does nothing to address the disadvantage our tax system creates for income from work relative to income from wealth. Income from wealth is not subject to the Medicare or Social Security payroll taxes and some income from wealth (like capital gains and stock dividends) is subject to special, low rates in the regular income tax that have no justification.
Expanding the part of the Medicare tax that is paid by individuals (which is currently the 1.45 percent payroll tax paid by employees) to investment income would reduce this unfairness while providing more revenue for health care. And it would do so by closing a gap in the one major health care tax we already have.