Health Bill Would Add 3.8% Tax on Investment Income

Bloomberg News | By Ryan J. Donmoyer

Democratic congressional leaders would raise to 3.8 percent the Obama administration’s proposed new Medicare tax on investment income to generate an estimated $210 billion to help fund a health-care overhaul plan.

The rate is higher than the 2.9 percent President Barack Obama proposed in February. The new tax would apply to income from interest, dividends, annuities, royalties, capital gains and rents for individuals who earn more than $200,000 annually and joint filers reporting more than $250,000, according to the legislation.

“It’s a big deal,” said Clint Stretch, a tax analyst for the consulting firm Deloitte Tax LLC. “It extends dramatically the reach of the Medicare hospital insurance tax.”

The first-time Medicare tax on investment income would start in 2013. It would push tax rates on capital gains and dividends that year to 23.8 percent for high-income people if Congress goes along with Obama’s proposal to let those rates rise to 20 percent in 2011 from the current 15 percent. It would be the highest rate for long-term capital gains since 1997.

The nonpartisan staff of the congressional Joint Committee on Taxation estimated the Medicare tax on investments would generate more than $30 billion annually, or $210.2 billion from 2013 through 2019. It would be the biggest tax increase in the bill and account for half of the $409 billion in total revenue.

Overall Rates
Overall tax rates on income from interest, annuities and royalties would rise to as much as 43.4 percent. The Medicare tax wouldn’t apply to income in tax-deferred retirement accounts such as 401(k) plans.

Obama proposed extending Medicare taxes to investment income as lawmakers sought to merge the House health-care plan, which included a 5.4 percent income surtax on millionaires, with the Senate proposal, which sought to tax expensive health insurance plans over the objections of labor unions.

The final plan announced today delays the proposed 40 percent tax on high-value insurance plans until 2018, from 2013 in earlier proposals. It also increases the cost threshold affected by the tax, applying it to the portions of plans worth more than $10,200 for individuals and $27,500 for families. The Senate bill would have imposed the tax at thresholds of $8,500 and $23,000.

In further years, the tax on high-cost plans would affect more insurance plans than earlier proposed, as the plan would reduce the inflation index for that provision.

Union ‘Victory’
“Clearly, unions and others concerned with high-cost plans have won a victory in this,” Stretch said. The Medicare tax on unearned income “is a compromise, if you will, between the House and the Senate on the level of high-income taxation that goes into the mixture.”

The tax on high-cost insurance plans would generate about $32 billion in 2018 and 2019, according to the Joint Committee on Taxation. That’s a fraction of the original Senate proposal to generate about $149 billion from the levy.

The current 2.9 percent Medicare tax applies only to salaries and is split evenly between workers and their employers.

The bill adopts a Senate-passed proposal to increase an employee’s share of that amount by 0.9 percentage points, to a total 2.35 percent, for high-income workers. That would be added to the worker’s top marginal rate, which under Obama’s other tax proposals would rise to as much as 39.6 percent.

Flexible Accounts
Separately, the legislation would delay until 2013 a new $2,500 cap on the amount of money workers can contribute on a pre-tax basis to employer-sponsored flexible spending accounts to pay out-of-pocket medical expenses. The Senate version of the plan would have imposed that limit starting in January. The new proposal would generate about $13 billion in revenue by 2019, according to the joint tax panel.

Today’s proposals are “a radical change from U.S. tax policy without much debate at a time when we should shift the fundamental core of U.S. tax policy in a more pro-saving and investment” direction, said Mark Bloomfield, president of the American Council for Capital Formation, a Washington group that lobbies for lower taxes on capital.

Democrats are seeking the biggest health-care changes in more than four decades. Americans would be required to get insurance, with subsidies and purchasing exchanges to help. Insurers such as Philadelphia-based Cigna Corp. would get millions of new policyholders and be required to accept all customers.

Tanning Services
The bill also would impose a 10 percent excise tax on indoor tanning services that is projected to raise $2.7 billion. For everyone but retirees, it would increase to 10 percent the share of income a person would have to spend on out-of-pocket medical expenses before being allowed to deduct them. The current floor is 7.5 percent. The change is projected to generate $15.2 billion.

The legislation would limit health insurance companies’ tax deductions for pay in excess of $500,000 to their executives.

It would prohibit paper makers such as International Paper Co. from claiming a $1.01 tax credit for producing fuel from a type of pulp-making byproduct called black liquor. While International Paper and other forest product companies said they weren’t seeking the credit, the IRS determined they might be eligible.