Why the new medicare tax is a bad idea

On January 1, 2013, the Affordable Care Act's 0.9 percent  Medicare tax increase goes into effect, hitting individuals earning more than $200,000, and married couples earning more than $250,000.  While a payroll tax increase from 2.9 percent to 3.8 percent may seem tiny, it is a bad idea. Many scholars have expertly weighed in on the adverse consequences of Obamacare's misguided Medicare tax increase on investment income. But, there also are pernicious consequences of the new payroll tax affecting wages and salaries.

First, tax increases on the rich don't work. AEI president Arthur Brooks and outgoing Heritage Foundation president Ed Feulner eloquently explain how higher taxes don't raise enough revenue and hurt small business. But one important point left out of their argument: higher tax rates on the wealthy don't necessarily ensure the rich pay a higher share of taxes.

After the Bush tax cuts, the top income earners paid a higher share of federal income taxes than they did before the cuts; in fact this share quickly exceeded the share they paid during the Clinton years when the top marginal tax rate was 39.6 percent.[1]  If we measure the impact of the Bush tax cuts starting in year 2003 (the year they went into effect), the chart below shows the share of federal income taxes paid by the top 1% and top 5% of taxpayers began rising immediately and did not stop rising until the financial crisis in 2008.

Moreover, the annual increase in federal income tax revenues from the first four years of the Bush tax cuts (10.5 percent) was greater than the annual increase in tax revenues from the first four years of the Clinton tax increases (9.6 percent). The same can be said about the increase in federal income taxes paid by the top 1% which grew 15.2 percent under Bush, but only 13.3 percent under Clinton. [2]

There's a second reason raising the Medicare tax is a bad idea. At the margin, each new federal tax dollar shrinks the economy by at least 40 percent. For this reason, and especially when Medicare's unfunded liabilities already exceed $100 trillion, it makes no sense to use scarce federal tax dollars to subsidize Medicare coverage for people like Warren Buffett (or, if you prefer, the Koch brothers). That's because when we use taxes to pay for retiree health care for such individuals, it actually costs the economy $1.40 for every dollar of medical care paid by Medicare.

If instead these individuals paid the full premiums for their retiree health coverage directly, it would eliminate the deadweight losses caused by financing their Medicare with tax revenues.  (Remember such deadweight losses harm all of us, not just those at the top of the income distribution). In short, everyone would be better off. Medicare spending would decrease by the amount that would have been spent on wealthy individuals, and the economy would save $1.40 for every tax dollar government didn't spend.

The last reason to avoid a Medicare tax increase: our entitlement programs are already heavily financed by the rich. In 1993 Bill Clinton lifted the maximum income cap to which Medicare payroll taxes applied-a dramatic philosophical change in Medicare financing.

Prior to this increase, the highest income earners paid a fixed dollar amount that roughly corresponded to a prepaid premium for Medicare coverage. Once the cap was lifted, it meant that a millionaire, for example, might end up paying 10 times as much for Medicare as he had previously even though the Medicare benefit had not changed at all.

Instead of being modeled after an insurance plan (which is how FDR had sold Social Security to the American public), Medicare became much more nakedly an entitlement disproportionately financed on the backs of "the rich."  In that regard, the Obama Medicare tax merely amplifies an already undesirable change in policy.

Singling out a small segment of the population for a tax hike is a bad idea as it fuels the politics of envy. Envy is not an admirable character trait. It certainly cannot be found among the 110 Rules of Civility & Decent Behavior in Company and Conversation that helped shape the character of Founding Father George Washington. Fueling resentful instincts of the electorate is morally repugnant, particularly for the only elected leader who is supposed to represent all Americans-not just one party or one class. Admittedly, the current president is not the first to deploy us-vs.-them rhetoric. One could argue it began with FDR's attacks on "plutocrats" during the 1930's and past Republican presidents likewise have been accused of us-vs.-them rhetoric. But that doesn't make it right.

In short, on the grounds of efficiency, effectiveness and fairness-not to mention national character-the new Medicare payroll tax deserves a second opinion. If the nation is going to have a serious discussion about how to reform Medicare and its financing, the payroll tax increase needs to be on the table.

Footnotes

[1] In both administrations, the rise in the share of income paid by the top 1 percent declined due to recession. The Clinton recession (which began in March 2001) ended in November 2001. The Bush recession began in December 2007. In 2008, the adjusted gross income of the top 1 percent declined by 16.1 percent versus only a 4.3 percent decline for taxpayers in general.

[2] Since the Clinton tax increases were made retroactive to January 1, 1993, my figures are based on the increase in revenues between 1993 and 1997. Skeptics may think I'm cherry-picking the data, but remember that Clinton famously cut taxes in 1997 (whether he was "forced" to do so by Republicans is immaterial for my argument: what matters is that he did it). But even if we assess the Clinton track record over his entire tenure, 1993-2000, my claim still holds. Total federal income taxes rose only 10.0% annually during that period (versus 10.5% for Bush) and taxes paid by the top 1 percent rose by 14.1 percent annually, versus 15.2 percent for Bush.

Maybe only policy wonks will care, but I find it quite interesting that the performance during the Bush tax cut years was nearly identical to the performance that occurred in the Clinton era after he cut taxes in 1997: 10.5 percent annual growth in overall income taxes in both periods and 15.0 percent increase in income tax revenues for the top 1 percent under Clinton from 1997-2000 versus only slightly higher 15.2 percent growth in their income tax revenues under Bush. In light of this evidence, I am puzzled why anyone would advocate a return to Clinton-era tax rates, as that would appear to be a prescription both for slower growth and a lower share of taxes paid by the top 1 percent. Is that really what President Obama and progressives in Congress want?

 

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Christopher J.
Conover

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