Here’s a new tax on savings you didn’t know about

Article Highlights

  • The unearned income Medicare contribution tax will further raise tax rates on income from saving.

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  • The obscurity of the unearned income Medicare contribution tax has allowed bizarre myths to circulate on the internet.

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  • If we can’t repeal the unearned income Medicare contribution tax, we should at least remember its burden on saving.

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In the debate over the looming fiscal cliff, U.S. President Barack Obama often plays down any adverse economic impact from letting the 2001 and 2003 tax cuts expire for high-income Americans, claiming that the top tax rates would merely return to where they were during the Clinton years. Unfortunately, the president's claim is incorrect because he ignores the impending arrival of the unearned income Medicare contribution tax, which will further raise tax rates on income from saving.

Scheduled to take effect on Jan. 1, the tax, which was adopted as part of the 2010 health-care law, is a 3.8 percent levy on interest, dividends, capital gains and passive business income received by taxpayers with incomes exceeding $200,000 (or $250,000 for couples).

Because the new tax was added to the health-care law late in the process without congressional hearings, it received little attention at the time. With only a few weeks left before it takes effect, it remains largely unknown.

Its obscurity has allowed bizarre myths to circulate on the Internet -- despite what you may have read online, the tax is not a 3.8 percent levy on home sales.

One problem with the unearned income Medicare contribution tax is the name Congress chose for it, which is a triple misnomer. The income that will be subject to the tax isn't unearned -- it is earned by savers who receive market rewards for delaying consumption and providing funds to finance business investment.

Also, because the proceeds will be paid into the general treasury, the tax will have no financial link to Medicare. And, of course, the tax will be a compulsory payment, not a voluntary contribution.

Intricate Regulations

Another concern is the complexity of the tax, as demonstrated by the intricate proposed regulations the Internal Revenue Service has had to develop to carry it out. The regulations, which still leave a few implementation issues unresolved, and the accompanying explanation filled 42 pages of the Dec. 5 Federal Register.

The biggest issue, however, is the additional penalty the tax will impose on the savings that finance investment and fuel long-run economic growth. It's true that relatively few Americans have high enough incomes to be subject to the tax. But they account for a large portion of what the nation saves, magnifying the economic impact.

IRS data for 2010 reveal that the 3 percent of taxpayers with incomes of more than $200,000 received 45 percent of the interest income, 58 percent of the dividends and 88 percent of the capital gains (net of losses). More taxpayers and more saving will gradually become subject to the unearned income Medicare contribution tax in coming decades because its income thresholds won't be adjusted for inflation.

Even if the high-income portions of the 2001 and 2003 tax cuts are fully extended, the unearned income Medicare contribution tax's arrival next year will raise the top rates on interest, dividends and capital gains 3.8 percentage points above this year's levels. Or, if the high-income provisions are allowed to expire, it will push the top rates on interest, dividends and capital gains 3.8 percentage points above Clinton- era levels.

Even if we can't repeal this tax, we should at least keep in mind its burden on saving as we decide the fate of the 2001 and 2003 tax cuts.

Finally, if we keep the unearned income Medicare contribution tax, we should give it a more accurate name. The IRS is now calling it the "net investment income tax." I prefer to call it a "tax on income earned by savers."

Alan D. Viard is a resident scholar at AEI.

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About the Author

 

Alan D.
Viard
  • Alan D. Viard is a resident scholar at the American Enterprise Institute (AEI), where he studies federal tax and budget policy.

    Prior to joining AEI, Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also been a visiting scholar at the US Department of the Treasury's Office of Tax Analysis, a senior economist at the White House's Council of Economic Advisers, and a staff economist at the Joint Committee on Taxation of the US Congress. While at AEI, Viard has also taught public finance at Georgetown University’s Public Policy Institute. Earlier in his career, Viard spent time in Japan as a visiting scholar at Osaka University’s Institute of Social and Economic Research.

    A prolific writer, Viard is a frequent contributor to AEI’s “On the Margin” column in Tax Notes and was nominated for Tax Notes’s 2009 Tax Person of the Year. He has also testified before Congress, and his work has been featured in a wide range of publications, including Room for Debate in The New York Times, TheAtlantic.com, Bloomberg, NPR’s Planet Money, and The Hill. Viard is the coauthor of “Progressive Consumption Taxation: The X Tax Revisited” (2012) and “The Real Tax Burden: Beyond Dollars and Cents” (2011), and the editor of “Tax Policy Lessons from the 2000s” (2009).

    Viard received his Ph.D. in economics from Harvard University and a B.A. in economics from Yale University. He also completed the first year of the J.D. program at the University of Chicago Law School, where he qualified for law review and was awarded the Joseph Henry Beale prize for legal research and writing.
  • Phone: 202-419-5202
    Email: aviard@aei.org
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    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

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