How do politicians enact a substantial middle class benefit like health care reform when many in that middle class are happy with their health insurance? They rely on a bad economy that create doubts in many that their health insurance may be in jeopardy. They rely on the generosity of the American people who do not want to see their fellow Americans without any health insurance. The clincher, however, is for them to convince the middle class that they will be getting something for nothing. Ergo a millionaire surtax that will be paid by less than 1% of taxpayers.
The answer ...
Small Business. However, the high income tax surtax is not painless for the middle class. Its cost will fall principally on those small family businesses that create 80% of our jobs, and the middle class already suffers from a desperate shortage of jobs. Politicians can be sure that the middle class will notice a jobless recovery, assuming recovery can even begin. Almost all small businesses have "pass-through treatment" where the owners include the business income in their federal income tax returns and then pay tax on it, whether they receive cash or not. Thus, family and other small businesses pay tax not at corporate rates, but at individual rates. Small business owners, therefore, have to pay the surtax or any tax increase in marginal rates on their business income whether they spend the money or reinvest it in their businesses, leaving the owners with less capital to expand or hire. On the other hand, big international corporations pay nothing more in tax, leaving small businesses at a competitive disadvantage and unable to raise prices to offset the increased tax.
An American Solution to Pay for Health Care. Thankfully Americans are not whiners who expect something for nothing as the politicians apparently believe. Americans understand that health care reform is insurance against job loss or a family medical disaster. Americans are willing to share the cost of providing insurance to the uninsured. Americans are smarter than the politicians and understand that universal health care requires a universal sharing of the cost. Health care reform can be paid for by a universal tax reflecting American values without burdening anyone unfairly. Moreover, the universal tax will pay for health care reform while creating and preserving jobs, making income taxes fairer and more efficient, offering a model for future tax reform and holding politicians accountable for truly reforming health care. Congress should reform the existing Medicare tax into a Universal Health Care tax.
Medicare Tax. Under our current system, social security and Medicare taxes are imposed only on earned income and on top of the federal income tax. Investors with unearned income such as interest, dividends and capital gains, therefore, pay no Medicare tax. Because social security benefits are tied to lifetime earnings, linking social security taxes to earned income makes sense. However, Medicare benefits bear no relationship to earned income and, thus, should be imposed on both earned and unearned passive income. The Medicare tax currently is collected at a 2.9% rate with employers splitting the cost with employees (and the self-employed paying both halves).
Business Taxes. Small business income is taxed like salaried and other productive earned income, meaning small business owners must also pay the Medicare tax (and social security tax) on their business income in addition to paying the tax as employers and employees. All public and international corporations pay the corporate income tax and, therefore, do not pay the Medicare or social security taxes on their business income, nor do their owners pay Medicare or social security taxes on the dividends they receive. Because the owners of public corporations pay taxes at a 15% rate on dividends on income already subject to corporate tax at a 35% rate, some argue that corporate business income is subject to "double-taxation." However, those who see unfair double taxation simply misunderstand the real purpose of the corporate tax: equalizing the treatment of small businesses and big businesses by imposing the same tax rate on business income. Without a corporate income tax, big businesses would enjoy an unfair advantage over small businesses. Because the individual income tax is based on ability to pay, dividends are taxed as are other forms of cash income. The current 15% income tax on dividends and capital gains and the zero tax on exempt interest belie that fairness as taxpayers with productive earned income pay tax at a rate two and a half times the rate investors with passive unearned income.
Small Businesses Are Already Tax-Disadvantaged. The top individual income tax rate is 35% so small business owners start by paying the same rate on their business income as their big publicly-traded competitors. However, small businesses then have to pay the 2.9% Medicare tax on their business income (plus a 12.4% social security tax on the first $90,000 of earned income). Moreover, in 2011 that rate on small business income increases to 39.6% while the rate on corporate income remains 35%. Small businesses then will pay tax at a rate more than 20% higher than their corporate competitors. The low rates paid by investors on dividends and capital gains further disadvantage small business owners. Because buyers of public corporation pay taxes at such a low 15% rate on dividends and capital gains, the corporations can price their capital much lower than owners of a small business who have to pay the current 37.9%. A 5% surtax would mean an additional 2% increase in rates. Small businesses typically finance growth and reinvestment from business income. Ironically family business owners pay more tax on income from reinvesting in their own businesses than from passively investing in their competitors’ big businesses – more than two and a half times.
Paying for Health Care Reform Fairly. A surtax on individual income taxes will fall on small business owners making the tax system less fair and depressing the economy further. Universal health care can be financed, while making the income tax system fairer to family businesses. Congress should redirect the existing Medicare tax to fund all health care and impose it on passive unearned income as well as earned income. Because the goal is universal medical insurance, the Universal Health Care ("UHC") tax should be imposed as broadly as possible. Not only on passive income such as interest, dividends, gains, royalties and rents, but also on tax exempt interest and corporate income. States and municipalities will benefit greatly from health care reform and should shoulder a bit of the burden indirectly by a possible slightly higher rates by borrowing. Imposing the UHC tax on corporate income will reduce the tax advantages that big businesses enjoy over small businesses. Charities already pay regular income tax on their unrelated business income; Congress should consider charging the UHC tax against their unrelated business income and their passive investment income.
Model for Tax Reform. In addition to establishing the principles that the tax system should be fairer to small businesses and that income taxes should be broad based, the UHC tax could be a model for improving the current income tax system in other ways. First, the existing Medicare tax is paid through withholding earned income. The UHC tax also should be paid primarily through withholding on unearned income. Second, just as the Medicare tax is paid independent of the income tax so would the UHC tax. The costs of, and the benefits from, universal health insurance will be spread broadly. Finally, the Medicare tax fund will be replaced with the Health Reform fund and all of the UHC taxes would go to that fund. Unlike the Medicare tax, however, the UHC tax rate would adjust annually to a rate necessary to fund Medicare, Medicaid and any other universal health care benefits for that year. Politicians, therefore, would be accountable to taxpayers for their stewardship of health care reform.
Accountability. Including a public option in health care reform should be less objectionable, if taxpayers are able to judge the cost of the option by the UHC tax rate. Because the UHC tax rate will be set annually, it will provide a brake to increasing health care costs, thereby reducing the future costs of health care. Just as deductibles limit individual from choosing unnecessary health care, an automatically increasing UHC tax rate will limit politicians from providing unaffordable government health care benefits. The discipline provided by an automatic UHC tax should attract wavering Republicans to the public option.
Tax Justice. Citizens for Tax Justice ("CTJ") recommends an expansion of the 1.45% Medicare tax to unearned income. However, CTJ does not extend it to corporate income thereby missing the opportunity to reduce the unfair advantage that big businesses enjoy over small businesses. (I am not sure that CTJ believes that small business owners deserve tax justice.) Indeed, CTJ proposes to increase the unfairness by raising the tax from 1.45% to 2.5% on higher productive incomes. It is simply impractical to have a multi-tiered tax rate on a tax that is withheld as the Medicare tax is currently and as proposed for unearned income. Moreover, CTJ wants to limit the Medicare tax paid by seniors who make less than $50,000. They fail to explain how giving seniors who benefit substantially from government health care a complete pass on helping to pay for that care is "tax justice." The proposed UHC tax would be applied to pensions, IRA distributions and other deferred compensation as the Medicare tax would have been avoided at the time the benefits were funded. Also by broadening the tax base to include unearned income, the aging of the population and the shrinkage of workers to beneficiaries will have less adverse impact on funding.
Lowering the Medicare Tax Rate. Based on the computations of CTJ and other sources, it appears that a broad based UHC tax could be set at a rate lower than the current 2.9%. Lowering the payroll taxes has been discussed as one of the most effective means of providing a second stimulus. Lowering the Medicare tax rate would provide a real incentive for limiting the costs of health care reform. Unlike the proposed surtax, by lowering tax rates on earned income the UHC tax could increase jobs and strengthen the economy.