Obamacare and tax reform: a progressive double play (Part I)

This is the first in a series of posts about paying for the Affordable Care Act

You’ve probably never heard of section 9015 of the Affordable Care Act. A Google search turns up few media hits, mostly uncovering links to really boring official government documents and dry consultant reports.

But that unassuming section contains some of the most far-reaching parts of the ACA. It not only is the single largest item of funding to pay for the law, but its passage is the single most progressive piece of tax reform over the last 20 years – and arguably since the institution of the graduated income tax.

In fact, the ACA as a whole is notable not only for the massive benefits that it showers on middle and lower-income Americans, but also for the progressive way it pays for them – by increasing tax rates on wealthy individuals and large companies, eroding corporate welfare, and closing numerous tax loopholes that tend to benefit narrow sets of businesses and wealthy individuals.

Tomorrow, I’ll examine other new taxes in the ACA, while later posts will discuss tax loopholes that Obamacare closes and changes to government subsidies to health care providers.

But for now, follow me below the fold for a description of section 9015.

 First, a basic primer on American tax policy:

When it comes to paying federal taxes, most Americans pay two types. The first type is the income tax, which is progressive (graduated), meaning that the rate increases as your wage increases. On roughly the first $9,000 of income, earners pay zero tax (depending on deductions and exemptions). On income above that, rates steadily increase, capping out at 39.6 percent on income above $400,000 for single earners.

Payroll taxes, which fund Social Security and Medicare, are regressive – that taxpayers with lower incomes pay higher percentages of their incomes in tax. Employees pay 6.2 percent in Social Security tax on the first $113,000 of their income (The employer kicks in the other half, so the self-employed owe 12.4 percent).  As a result, a welder making $35,000 a year pays 6.2 percent of his income in Social Security tax, while the owner of the welding company making 1.13 million pays 0.62 percent of his income to Social Security.

The Medicare tax used to be regressive as well, until the Clinton budget bill of 1993 lifted the cap and subjected all wages to the 1.45 percent tax (this was a large progressive achievement).

Second, note how these taxes all apply to wages – the government taxes investment income at a lower rate and escapes payroll taxes altogether.

Section 9015 of the ACA breaks through both regressive features of the Medicare payroll tax. First, it increases the tax rate on wages above $200,000 for singles and $250,000 for couples to 2.35 percent, making the payroll tax truly progressive for income.  Second, the provision adds a tax of 3.8 percent of all investment income of all taxpayers with an adjusted gross income of $200,000 or more ($250,000 for couples)

This is the first time in the history of the United States that investment income has been subject to payroll taxes. The two changes together will bring in $230 billion for the U.S. Treasury between 2013 and 2019, paying for roughly one quarter of the costs of the ACA and greatly enhancing the progressiveness of the American taxation system.

 Here’s Senate HELP staffer, reformer and scholar John McDonough on the change in his must-read book:

“Though this provision received scant public attention…. It represents a major shift in federal tax policy – for the first time, unearned income will be subject to Medicare taxes, albeit less than for earned income. For progressives, this is an enormous and positive breakthrough in tax policy heretofore considered untouchable; to conservatives the policy is anathema. It is a considerable factor in the conclusion reached by the Medicare trustees in August 2010 that the ACA will extend the solvency of Medicare Hospital Insurance Trust fund from 2017 to 2029.  It is impossible to imagine this provision as part of a bipartisan health reform agreement. Had it ever got to that point in negotiations, section 9015 would most certainly have been a deal breaker for Republicans. Because they were not at the table, it was acceptable, desirable and doable choice for Democrats. And the barn door is now open.” (257-258)

If this was the battle of Waterloo – it’s not quite how former Sen. Jim DeMint (R-S.C.) envisioned it going.

Tomorrow, I turn to the other direct taxes and  levies in the ACA.