Baucus beats Pelosi on health tax policy

This op-ed was published in the Detroit News on November 06. 2009.

If sound tax policy were the guide of Congress, the choice would be easy between Sen. Max Baucus’ health plan and the new House version from Speaker Nancy Pelosi. The Baucus plan would get the nod.

Both want to fund new government insurance subsidies for working-age, middle-income people, but their methods of raising the money to pay for them is quite different. The Baucus plan is sounder because his idea of taxing expensive health insurance policies, dubbed “Cadillac plans” in the press, will do much less damage to the economy than Pelosi’s idea for a new surtax on income.

How would the government tax these Cadillac plans? Every health insurance policy whose premiums are higher than $8,000 for an individual ($21,000 per year for a family of four) would be taxed at the rate of 40 cents for every dollar over those thresholds.

So if your company is paying Blue Cross $10,000 to cover you as a single individual, Blue Cross would have to pay the federal government $800 (40 percent of the $2,000 over the threshold). If the premiums cost less than $8,000, the tax wouldn’t kick in.

The virtue of this tax compared to others is that it targets a previously tax-exempt stream of income, which in tax terminology means that it “broadens the base.” As every expert on public finance agrees, no matter what political leaning, our tax code’s current favoritism toward employer-provided health insurance is a major reason we spend so much on health care.

Sen. Baucus’ excise tax might reasonably be expected to “bend the curve” of health care spending; that is, it would reduce the public’s appetite for policies that cover everything from eyeglasses to aromatherapy with low deductibles.

By contrast, the House tax plan could have no restraining effect on health spending. The principal funding mechanism in Pelosi’s plan is a surtax that would push marginal income tax rates on wages beyond 50 percent for high-income workers. House Democrats’ determination to tax wages more heavily and to protect the tax-exempt status of Cadillac health insurance plans mostly reflects pressure from labor unions that have bargained for very expensive health insurance coverage.

But high wages are already in the crosshairs for a tax hike on Jan. 1, 2011. That’s when the Obama budget calls for keeping all the Bush tax cuts for low- and middle-income people but allowing the cuts for high earners to expire. The top tax rate will rise to 39.6 percent from 35 percent. On top of that, the Medicare tax will still take 2.9 percent, and the new Pelosi surtax would take 5.4 percent. Add in an average state-local income tax rate of about 6 percent, and the total rate is well over 50 percent.

Although most people are describing the surtax as if were just like another income tax bracket, it is actually a much bigger tax. Instead of taking 5.4 percent of “taxable income,” the new surtax would take 5.4 percent of “adjusted gross income” (AGI), which is much larger than taxable income. Taxing AGI means disallowing popular deductions like mortgage interest, charitable gifts, and state-local tax payments, and AGI includes capital gains and dividends so that those income streams, currently taxed at a 15 percent rate, would be taxed at 25.4 percent in 2011.

About a million taxpayers would pay the new surtax at first, but because the House has decided not to index it for inflation, the number of families hit by it would grow rapidly. That’s what happened with the alternative minimum tax, another tax that was supposed to hit only millionaires but over time became a nightmare for many others.

Some people dispute the idea that Americans spend too much on health care, pointing out that our quick access to high-tech medicine is bound to cost more, and that it’s worth it. But much of the public is convinced that we should spend less and more efficiently. The Baucus plan reflects this sentiment by putting a brake on subsidies for the most lavish insurance plans, and it avoids further income tax hikes that would hurt the economy.

The Pelosi plan fails on both those counts, so if either of these plans prevails, the nation would be better off with Baucus.