Five Questions About President Obama's Proposed Changes To The Medicare Payroll Tax
By Christopher Weaver
KHN Staff Writer
Mar 09, 2010 - Kaiser Health News
Should affluent Americans have to pay Medicare payroll tax on their
investment income?
President Barack Obama, to help pay for his health
care overhaul package, is proposing that high-income Americans pay Medicare
taxes on the money they make on their investments. Historically, only earned
income has been subject to that tax. He also wants to increase the Medicare tax
rate on wealthy Americans' wages.
Here are some basic questions and answers about this little-discussed
provision that could affect millions of people:
1. What did Obama
propose?
Obama's health care plan, released
Feb. 22, would cost roughly $950 billion over 10 years and extend health
insurance to about 31 million Americans who are currently uninsured, according
to White House estimates. To help raise money for that effort, the president
proposed the new tax on investment income and the increase in Medicare tax rates
for the wealthy. The rate increase also is in the Senate-passed bill.
The new investment and payroll taxes would raise about $184 billion by
2019, according to a preliminary analysis
by the Joint Committee on Taxation.
Another Obama funding source for a
health overhaul -- a tax on high cost "Cadillac"
health plans, also is included in the Senate bill. But by picking up
revenues through proposed changes in the Medicare tax, Obama was able to water
down the Cadillac tax - a key White House goal, given labor union's opposition
to it. The president's Cadillac provision would generate only about one quarter
of what the Senate's proposal
would raise. That's because implementation would be delayed and the tax would
apply to fewer plans.
2. How would the Medicare taxes
work?
Under Obama's plan, individuals with incomes of more than
$200,000 - including both wages and investment returns -would pay a 2.9 percent
tax on interest, dividends, royalties and other unearned income that exceeds
that threshold. Couples with total incomes over $250,000 would face the tax,
too.
The proposal would also increase the 1.45 percent Medicare payroll
tax on workers' wages to 2.35 percent on earnings that exceed $200,000 for an
individual and $250,000 for a couple. The portion of the Medicare payroll tax
paid by the employer would remain at 1.45 percent.
Under this plan, a
couple that earns $275,000 in salaries and $150,000 from investments would pay
the normal 1.45 percent on the first $250,000 of their wages. They would pay
2.35 percent on the last $25,000 of wages. And, because their total income tops
$250,000, they would face the 2.9 percent tax on all $150,000 of their
investment income.
Right now, that couple would pay $3,987.50 in Medicare taxes each year. Under
the proposal, they would pay $4,212 on their wages and $4,350 on their
investment income, $8,562, assuming all of that income is taxable. Congressional
estimators predict any final policy would include some exemptions, such as the
costs of generating investment income.
3. Who would be affected?
Taken together, both the earned- and investment-income portions
of the tax would
hit the top 2.6 percent of U.S. households, according to The Tax Policy
Center, a joint project of the Urban Institute and the Brookings Institution.
That would allow Obama to keep his campaign promise not to raise taxes for 95
percent of the country's households.
The tax on investment income would
not apply to some non-wage income from certain small businesses. Under current
law, employees of S
corporations, a type of company with a limited number of shareholders, are
able to receive some of their income as distributions - a share of the
companies' profits - rather than as wages.
Lobbying by business groups
helped ensure that S corporations' employees who are also shareholders wouldn't
face the new tax on their share of the profits. However, people who
invest in S corporations, but do not participate in the operation of the
business, would have to pay the new Medicare tax on any dividends or other
unearned income they receive from the business.
4. How does the
Obama plan compare to Democratic congressional proposals?
Democratic leaders working toward a compromise between the
House and Senate bills had tentatively reached a labor-backed compromise that
included a Medicare tax on investment income less than a week before Republican
Sen. Scott Brown's Jan. 19 election in Massachusetts undercut Democrats'
filibuster-proof majority and stalled the debate.
The investment-income
tax was suggested last year by Sen. Debbie Stabenow, D-Mich., but senators
rejected the plan. The Senate also refused to accept a House plan to increase
taxes on the rich. However, the new taxes proposed by Obama have not provoked
any serious complaints from Senate Democrats yet.
The tax will likely
have some appeal to the more liberal House members, who resisted the Senate's
Cadillac tax. Unions, an important constituency for liberal House lawmakers,
have argued that the Cadillac tax would affect some middle-class union members
with high-value health benefits. Obama's proposal would subject fewer plans to
that tax.
5. What are the arguments for and against the idea?
Proponents of the tax changes, such as the liberal Center on Budget and
Policy Priorities, a think tank, argue that the
new taxes would hit only a tiny portion of American households and would
increase the fairness of the tax system. The group notes that,
currently, the wealthy pay a much smaller portion of their incomes in
Medicare taxes than do middle-class and lower-income Americans. That's because
the affluent get a bigger proportion of their incomes from capital gains and
dividends, which aren't subject to the payroll tax.
But critics,
including Rep. Eric Cantor, R-Va., the House minority whip, complained at
the recent White House health
summit that the investment tax, in particular, would hurt small
businesses and discourage investment. John Goodman, of the conservative National Center for Policy Analysis,
agreed. "When you're in a deep recession, the last thing you want to do is
reduce investment," he said. "And that's what happens when you tax investment."
© 2010 Henry J. Kaiser Family Foundation. All rights reserved.