What Would Surtax Rate Have to Be to Finance Kennedy Health Bill?

Congress is looking for money to pay for health care reform. The House Ways and Means Committee appears set to back a surtax on adjusted gross income above $200,000 (singles) and $250,000 (married couples). A 4-percent figure has been mentioned, but no definitive number has been set. The major health care initiative that has actually been proposed in Congress, however, is on the other side of the capitol. Sen. Ted Kennedy (D-MA) has put forth a bill entitled the Affordable Health Choices Act, versions of which the Congressional Budget Office has now estimated twice. The initial proposal came in with a shockingly high cost of $1.6 trillion over 10 years, and CBO has scored the revised Kennedy legislation as increasing the federal budget deficit by $597 billion from FY 2010-2019, with the huge increase coming in the latter years once the program was fully implemented.

Using the Tax Foundation’s Fiscal Incidence Microsimulation Model, we show that under a static score, a 2.4 percent surtax on high-income taxpayers would be enough to pay for a bill the size of Sen. Kennedy’s new bill, which is estimated to cost $88 billion in FY 2016. On the other hand, we also show that under a dynamic score that allows for the proposed tax increases to change taxpayer behavior, the rate in 2016 may need to be somewhat higher, closer to 3 percent or beyond. We choose fiscal year 2016 because it is the first full year in which the bulk of the initiatives in the bill would be in effect, and is thereby a representative of the typical annual cost of the bill.

The Obama administration has apparently reached an agreement with hospitals who have promised to save the government $155 billion over 10 years. Therefore, we also show what the required rate would have to be if these hospital savings actually accrue and Congress actually applies those savings to reducing the surtax instead of just spending more. It’s possible that the health care bill’s size will merely grow in response to these new hospital savings, and/or that the full hospital savings won’t ever occur.

Dynamic Estimates

Note that the 2.4 percent score percent score is purely static, and thereby assumes that no high-income workers or investors adjust their behavior as a result of the tax. But let’s assume that there is some supply-side effect that would shrink the size of the base (i.e. pre-tax income). These estimates are not dynamic in the sense of accounting for the macroeconomic effects of the tax hikes. They merely allow for micro behavioral adjustments.

For tax increases on middle-income groups, the static score is not going to differ much from a dynamic score. But for very high-income taxpayers, the economic literature shows that these taxpayers are much more sensitive to changes in marginal tax rates.

The table below shows how various sensitivities to tax changes among high-income taxpayers (i.e. behavioral changes that are tax-induced) would change the required rate. We present the results under both assumptions: (1) Assuming that government spends the hospital savings by just growing the size of the health care bill, and (2) Assuming that the entire hospital savings reduce the surtax.

AGI Elasticity (how sensitive taxpayers are to tax rates)

Required Surtax Rate Ignoring Hospital Savings

Required Surtax Rate Including Hospital Savings

Zero (static score, not sensitive)

2.4 %

1.8 %

0.4

3.0 %

2.2 %

0.8

4.0 %

2.9 %

1.2 (very sensitive)

5.4 %

4.2 %

Conclusion

As the results above indicate, by relying solely on a surtax on high-income individuals to pay for a health care bill the size of put forth by Senator Kennedy’s, the required rate is going to be between 2 and 3 percent given the chosen income thresholds. However, if the price-tag edges back to the original cost of the bill ($1.6 trillion), the required rate would likely be more than double the rates estimated here.

Notes:

(1) We allocated the $155 billion hospital savings to each fiscal year from 2010-2019 using each fiscal year’s share of the total ten-year window cost. (2) Since we base our results on a calendar year 2016 extrapolated microdata set, we estimate the required rate to raise $90.75 billion (which equals 75 percent of the FY 2016 amount of $88 billion plus 25 percent of the FY 2017 amount of $99 billion). This is because calendar year 2016 is partially in FY 2016 and partially in FY 2017. (3) Adjusted gross income elasticity is defined as the percent change in reported AGI for a 1 percent change in a taxpayer’s after-tax income.


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