The tax increases of the Reid plan on ObamaCare

What do the Reid and Pelosi plans for ObamaCare have in common?  Taxes, taxes, taxes — and Keith Hennessey breaks them down for us this morning.  The Joint Committee on Taxation identified six major new taxes or tax increases that will, according to Harry Reid, suck more than $370 billion out of the economy:

• 40% excise tax on health coverage in excess of $8,500 (individuals) / $23,000 (families). Amounts are indexed for inflation by CPI-U + 1% – begins in 2013 – $149 B tax increase
• Additional 0.5% Medicare (Hospital Insurance) tax on wages in excess of $200,000 ($250,000 for joint filers) – begins in 2013 – $54 B tax increase
• Impose annual fee on manufacturers and importers of branded drugs – begins in 2010 – $22 B tax increase
• Impose annual fee on manufacturers and importers of certain medical devices – begins in 2010 – $19 B tax increase
• Cut in half (to $500K) the amount of an executive’s compensation that a health plan can deduct from its corporate income taxes – begins in 2013 – $600 million tax increase
• Impose 5% excise tax on cosmetic surgery and similar procedures – begins for surgery in 2010 – $6 B tax increase!

Be sure to read all of Keith’s analysis, but pay particular attention to this:

Medicare payroll tax increase (§9015, beginning on page 2040)

Wow. It’s incredible that a Democratic leader would propose this.

Current law:

• Wages up to $106,800 in 2009 (and in 2010) are subject to payroll taxes of 15.3%: 12.4% Social Security + 2.9% Medicare.
• Wages above $106,800 are subject to payroll taxes of 2.9%.

My reading of §9014 of the bill tells me that Leader Reid proposes the following addition (changes in red):

• For individuals, wages between $106,800 and $200,000 for individuals are subject to payroll taxes of 2.9%.
• For individuals, wages above $200,000 are subject to payroll taxes of 3.4%. That’s a 0.5 percentage point tax increase. So for each $1K you make above $200K, you would pay $5 more in payroll taxes.
• For joint filers, wages between $106,800 and $250,000 for individuals are subject to payroll taxes of 2.9%.
• For individuals, wages above $250,000 are subject to payroll taxes of 3.4%. That’s a 0.5 percentage point tax increase. So for each $1K you make above $250K, you would pay $5 more in payroll taxes.

These threshold amounts of $200K and $250K are not indexed for inflation or wages, so more real income in each subsequent year will be subject to the 0.5 percentage point tax increase.

The additional 0.5 percentage point tax increase comes on the employee side, so you still pay income taxes on these additional amounts of taxes paid.

With this proposal, Senator Reid is leading Democrats across a major philosophical threshold. Since Social Security was created in the 30’s and Medicare in 1965, payroll tax revenues have been “dedicated” to financing these programs. While not all funding to finance Medicare comes from payroll taxes, all funding from the Medicare payroll tax finances Medicare. In other words, the 2.9% Hospital Insurance payroll tax that you and your employer pay on your wages is all supposed to offset Medicare spending. That is part of the social insurance model, in which everyone pays in a fraction of their wages, and everyone receives benefits later.

I am not a fan of the social insurance model, because it is non-transparent: most people think their individual taxes paid are being used to finance their benefits, when in fact the funds are used to subsidize other people’s benefits. But the social insurance model and dedicated payroll taxes have been a core principle of Social Security and Medicare financing since they were created, and advocates (especially on the Left) of those programs have fiercely defended this principle.

Leader Reid’s bill would use new Medicare payroll taxes to finance a new health entitlement outside of Medicare. His bill would turn Medicare payroll taxes into a general financing mechanism like the income tax. There is a slippery-slope argument against this that I would normally expect from the Left. If Republicans (or my former boss) had proposed this, I would expect AARP to come unglued and raise fears among seniors that, if this proposal becomes law, future Congresses might take payroll tax revenues and use them for highways or defense or other non-social insurance spending. I am interested to see how AARP reacts. Will they support the Reid bill as they did the House bill? (Reporters: There’s a story for you. Ask AARP.)

In addition, Social Security and Medicare payroll taxes have always worked from the bottom of the wage scale upward, because they are traditionally tied to benefit eligibility. Leader Reid is now creating a “donut hole” in which there are three rate “brackets.” This initiates and lays the groundwork for the future expansion of a progressive tax rate structure for payroll taxes. This makes it easier for future lawmakers to raise payroll taxes to finance other parts of government, because they’re just “taxing the rich.” While the Reid proposal applies only to wages at the top of the distribution, the principle would be in place to justify raising payroll taxes in that $106K – $200K in the future. Watch out.

Both of these are enormous precedents, long-term structural game changers in how we finance our government.

The non-indexing for inflation raises an interesting question about whether it breaks President Obama’s pledge. Was his $250K limit in real or nominal dollars?

This provision is a big risk for moderate Senate Democrats.

Is it as big of a risk for moderates as failing to pass a bill will be for Obama and the progressives?  That’s the big question.  Will people get angry enough over a new government entitlement that purports to solve a real issue for many Americans — the increasing cost of health care?  Never mind, for the moment, that it doesn’t actually solve that problem, but makes it worse.  Most won’t see that until 2013 at the earliest, by which point it will be far too late.

Reid canceled cap-and-trade, for all intents and purposes, by pushing the debate into the spring.  Reid can’t sell cap-and-trade as an entitlement program, after all.  It looks like he cleared the decks for a full-throated push on this bill, hoping to avoid questions such as the ones Hennessey raises.  And it might work, unless American voters get very vocal with their Senators, right now.

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