According to the official summary of the tax extender legislation that the House leadership released today (H.R. 4213), the bill contains substantial new tax increases on passthrough entities, oil and gas companies, and U.S. companies with foreign operations. Many of the bill’s provisions have been considered controversial in the past, and the contents of the bill have been kept secret until now even from members of the Ways & Means Committee. The House is expected to vote on the measure on May 21st or 22nd.
Among the bill’s provisions are:
Carried Interest – - recharacterization of 75% of investment manager income as ordinary income, subject to a transition rule (JCT is scoring);
Self-Employment Tax – - require service partners and S corporation shareholders to pay self-employment tax on distributive shares of income ($9.6 billion);
Foreign Tax Provisions – - Nine provisions raising a total of $14.45 billion over ten years, including repeal of the 80/20 rule; and
Barrel Tax - An 8-cents-per-barrel tax on oil and gas companies (JCT is scoring).
In an article for a NYU colloquium, tax professors Ed McCaffrey and Jim Hines recommend exploring spending as an alternative federal tax base, arguing that a “progressive spending tax” can achieve progressivity at a lower economic cost compared to the existing income and wage tax bases. They explain the advantages of the spending base as follows:
because one can escape or defer paying taxes under a progressive spending tax by saving, an activity with positive social externalities, the efficiency costs of high marginal rates under a spending tax can be mitigated
The time frame between introduction and full chamber action on major tax legislation has become ever more compressed, but the progress of the Medicare surtax provisions in the healthcare bill marks a new low in the deliberative process. With the exception of a few well-placed insiders in government, few individuals had any opportunity to review and comment on the scope or implications of the new tax.
Among other things, the new Medicare tax further weakens the link between contributions and benefits that have characterized Medicare and Social Security since their inception. Without even a hearing, Congress arguably has transformed Medicare from an insurance program funded by premiums deducted from wages into a spending program funded by a progressive income tax.
As explained recently by the President, his aim was to make Medicare funding more progressive, and he succeeded.
One benefit, perhaps, is that this should end the artificial hand-wringing over the Medicare or Social Security trust funds “going bankrupt.” The trust funds are merely a convenient fiction that allow tax writers and government economists to avoid including payroll taxes when discussing U.S. tax burdens.
Because the Medicare tax now applies to (nearly) all income, and because there is an ever weaker connection between the level of contributions and benefits, it has become misleading to exclude Medicare taxes in U.S. income tax rates.
The policy foundation that allowed Medicare contributions to be excluded before is now gone, and the new top rate should be stated as 43.4%. Similarly, the 35% rate that will kick in at around $250k of gross income in 2011 should be stated as 38.8%. At the same time, misleading headlines claiming that 50% of households pay no “income tax” should also be revised. The Medicare tax is an income tax.
Another important implication of the White House’s move is that it makes clear that the Administration supports removing the income ceiling on Social Security payroll taxes, notwithstanding the fact that the proposal is not included in the Administration’s FY 2011 Budget. Undoubetedly, plans to apply FICA tax to investment income also are on the Administration’s drawing board. That could raise the top federal rate to 55.8% (39.6% + 3.8% Medicare + 12.4% FICA) without any reported change in the statutory rate.
Given the Administration’s concerns about job creation by small business, it was surprising that the White House decided at the last minute to include business income in the base of the new 3.8% tax. This received no public scrutiny before it appeared in the health reconciliation bill 72 hours before a Sunday votes in the House of Representatives. It was a suprise even to tax professionals watching the process closely.
Among many other consequences, the now-enacted law will impact the ability of small businesses to raise capital, because investors will need a higher pre-tax rate of return in to justify any new investment. Yet, no one had any opportunity to comment.
Thus “tax policy” has become subservient to other more important policy goals. As a result, those who are already frustrated with the tax code’s complexity are likely to be disappointed as tax rules increasingly are used as the paddles and levers to control the great Oz of the American economy.
The comprehensive health care bill (H.R. 3962) that narrowly cleared the House on Saturday, Nov. 7th contains a number of significant tax provisions. In order of size, the provisions scored solely by the Joint Committee on Taxation are as follows:
AGI Surtax – - For the first time, the House has passed a tax on Adjusted Gross Income. The tax is 5.4% and kicks in at $500k for single taxpayers and $1m for joint filers. It would apply to capital gains, effectively creating a new 25.4% bracket for gains when the taxpayer’s AGI exceeds the relevant threshold. No credits are allowed against the tax, and it is not taken into account in calculating AMT. Because the 500k/1m thresholds are not adjusted for inflation, the surtax raises more money every year. The surtax would go into effect on 1/1/2011. According to JCT, total federal revenue from the surtax will amount to $460.5 billion during the first 9 years (from 2011 to 2019).
Narrow Biofuels Credit to Exclude “Black Liquor” – - $23.9 billion over 10.
Tax on Sale of Medical Devices – - Effective 1/1/2013, the House bill would impose a federal excise tax of 2.5% on the first sale of medical devices to a taxable or tax-exempt organization. A medical device is defined by reference to the Federal Food, Drug, and Cosmetic Act. The new excise tax is estimated to raise $20 billion over 10 years.
Information Reporting on Payments to Corporations – - $17.1 billion over 10.
Limit FSAs to $2,500, indexed for inflation – - $13.3 billion over 10.
Limitation on Treaty Benefits for Deductible Payments – - $7.5 billion over 10.
Repeal Implementation of Worldwide Interest Allocation – - $6 billion over 10.
Codification of Economic Substance Doctrine – - $5.7 billion over 10.
Conform Definition of Medical Expense for Various Code Provisions – - $5 billion over 10.
No Deduction for Certain Presription Drug Expenses – - $2.2 billion over 10.
20% Penalty for Nonqualified Distributions from HSAs – - $1.3 billion over 10.
In addition the tax provisions estimated by JCT alone, there are a few significant health-specific revenue raising provisions estimated by CBO and JCT together. These include, the “Tax on Individuals Without Acceptable Health Care Coverage” (a/k/a the Individual Mandate) and the employer mandate: a payroll surtax on employers electing not to provide health care coverage to employees.
Speaking on a Sunday morning talk show, Sec’y Tim Geithner made clear that the Obama Administration “will do what it takes” to bring the deficit under control. He did not repeat the President’s promise to limit the tax pain to those earning more than $250k when asked spcifically about that pledge.
Instead, he said that the future will demand “very hard choices,” and Geithner said only that the Administration would not add “unfairly” to the burdens facing ordinary Americans. He did not rule out a middle class tax increase and implied strongly that an increase will be necessary, even if the Administration is able to “bend thd curve” of ever increasing government health care costs. In Geithner’s words, controlling health care costs is “necessary but not sufficient.”
