Health care reform bill summary: powerful tax bombs, delayed fuses

The summary of the tax impact of the health care reform bill is that many of the big taxes to fund the legislation kick in later. Will they ever be paid?

Health reform is (almost) law. And while the Senate must still agree to a package of technical fixes approved by the House late last night, we now can see historic changes in the way we will buy health insurance. We can also see big new tax increases, at least for some relatively high-income people. But the most important won’t take effect for years. And there’s the rub.

I have never quite seen a law so full of powerful tax bombs attached to delayed fuses. The two biggest: A stiff new Medicare tax on high-earners that does not bite until 2013 and a tax on high-cost health insurance that does not kick in until 2018—long after the end of an Obama second term, if he has one.

Take the Medicare tax. Singles earning more than $200,000 and couples making more than $250,000 (in modified adjusted gross income) would pay an extra 0.9 percent of their wage income. Plus, they’d pay an entirely new tax of 3.8 percent on investment income. This effectively raises the rate on capital gains and dividends from 15 percent to nearly 19 percent. Initially, only about 2 percent of taxpayers would face the higher rates. But in an echo of the disastrous Alternative Minimum Tax, the earnings floor is not indexed for inflation so eventually many middle-class taxpayers could be hit by the levy. By 2018, the new tax would generate $37 billion.

The “Cadillac” tax on high-cost health insurance is the fave of nearly every economist, although it is widely disliked by the public. The current system that excludes the value of health care from tax is unfair since it is far more beneficial to high-earners (whose after-tax cost of insurance is reduced by 35 percent) than to low-wage workers (whose cost may be reduced by only 10 percent). It is also a big reason why consumers of health care are so disconnected from the true cost. After all, who cares about getting that unnecessary MRI if insurance is paying anyway?

Taxing those high cost health plans would encourage employers to offer cheaper policies, and workers could expect to get at least some of the cost savings back in wages, though economists argue endlessly about how much.

The final House-Senate compromise would change that--eventually. Health coverage in excess of $10,200 for individual plans and $27,500 for family plans would be hit with a 40 percent excise tax. Keep in mind the tax is only on the amount in excess of the floor, so with an $11,000 individual plan, only $800 would be taxed (the 40 percent rate would yield the government $320).

There are all sorts of exceptions. And the tax is indexed for inflation plus 1 percent. Today, the average family policy costs less than $14,000, far below the threshold. But since health costs have been growing much faster than regular inflation+1, the new tax would eventually hit many more workers—unless we can control medical costs. This tax is potentially a health care game changer. But it won’t take effect for 8 years.

Will any of us ever pay either tax? Who knows? The odds are very high that Congress will enact a significant tax reform long before anyone ever pays the Cadillac tax. And unions are poised to kill it. Similarly, the Medicare tax will be hugely controversial. Plus it eliminates a major revenue option for those who want to find new taxes to help balance the budget.

In the end, I’m betting that nobody will pay these taxes in quite the way the new law requires. It will be fun, however, to see how they change.

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