Deficit reduction plan would tax health insurance

No more tax breaks for employee health insurance plans, according to Bowles-Simpson deficit plan.

One of the most dramatic elements of the tax reform plan offered by the chairs of President Obama’s deficit commission, Erskine Bowles and Alan Simpson, was their proposal to eliminate tax breaks for employer-sponsored health insurance, contributions to retirement plans, and other employee benefits. When the Tax Policy Center did its first analysis of that proposal on November 16, our modelers assumed (perfectly reasonably) that if these benefits were now subject to income tax, workers would have to pay Social Security and Medicare payroll taxes on them as well.

Because these tax subsidies are so generous, a payroll tax on their value would generate a lot of money—more than $100 billion a year. And that extra levy would have a noticeable impact on the how taxes would be distributed among various earners under the plan. But after we published our analysis, the Bowles-Simpson staff told us they did not intend to hit workers with payroll tax on this income as well.

So TPC has run a new distributional analysis for the Bowles-Simpson plan without those extra payroll taxes. It turns out that everyone still pays more tax on average, but less, of course, than if they were hit with bigger payroll taxes. The lowest 20 percent of earners (who will make an average of about $12,000 in 2015 and who pay far more in payroll tax than in income tax) would pay about $200 more than they do today, instead of an average of $400 if they took a payroll tax hit as well. Their typical after-tax income would be cut by 2 percent, instead of 3.4 percent if they had to pay that extra payroll tax.

Middle-income earners (who’ll make about $60,000) will pay about $1,000 more instead of $1,900. Their after-tax income would be cut by about 2.2 percent instead of 4 percent. People at the top 0.1 percent of the economic food chain would also save about $1,000. But when you’re making an average of $9 million, and paying a half a million in new taxes, an additional thousand bucks is easily lost in the sofa cushions.

All the usual caveats apply to this analysis. Simpson-Bowles proposed several alternative reform plans. The version we modeled would eliminate all deductions, exclusions, and exemptions except for the child tax credit and the earned income tax credit, would end the Alternative Minimum Tax, tax capital gains and dividends as ordinary income, and set rates at 9,15, and 24 percent.

These estimates are for 2015 when everything is fully phased-in, and they are relative to current policy. That is, they assume the 2001 and 2003 Bush-era tax cuts are extended, most middle-income people remain protected from the Alternative Minimum Tax etc. If you prefer to use current law (where all those tax cuts end and we return to Clinton-era law), after-tax incomes actually rise on average for all but those making $32,000 or less or $9 million or more. The lowest earning 40 percent would pay about $200 more than they would compared to pre-2001 tax law. Also keep in mind we assume no behavioral response to these tax changes. Finally, the Bowles-Simpson staff reminds us that the co-chairs proposed several different tax reform plans and this one is not necessarily their preferred choice.

Make no mistake, whether your employer pays $10,000 for your health insurance premiums or pays you an extra $10,000 in wages, it is still income. Does it make sense to exclude this money from payroll taxes while subjecting it to income tax? I wouldn’t (although I’d use some of the extra revenue to expand the Earned Income Credit to help out very low earners). But, at least for now, Bowles and Simpson say that’s their plan—or one of them anyway. And now you know what it means.

Add/view comments on this post.

------------------------------

The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.