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Increase in Medicare Payroll Tax a Possibility for Senate Health Bill

By Richard Rubin, CQ Staff

November 12, 2009 -- Senate Democrats are considering raising the Medicare portion of the payroll tax to pay for expanding health insurance, a top Obama administration official said Thursday. Two congressional aides also confirmed the talks, and one said the idea comes from Majority Leader Harry Reid, D-Nev.

There are several variations of the idea "floating around," said Peter R. Orszag, director of the Office of Management and Budget.

The specifics of any plan are unclear, but liberal interest groups have been pushing the idea of expanding the Medicare tax instead of taxing high-cost health insurance plans. The House passed legislation last week (HR 3962) that would levy a surtax on individuals earning more than $500,000 per year. Reid's proposal is similar.

"To some extent it is a variation—depending on how they do it—it is a variation on the surtax," a House Democratic leadership aide said. "It is sort of going after a similar revenue source. To that extent, it has some potential."

Currently, workers and employers each pay a 1.45 percent payroll tax for Medicare. A set of proposals circulated earlier this year by the advocacy group Citizens for Tax Justice suggested applying the tax to capital gains and other investment income or setting up a 2.5 percent payroll tax bracket that would start at $250,000 of income.

The House aide said that applying the payroll tax to "unearned" income, like capital gains, would be more controversial than raising the rate of the tax for high earners. Applying the payroll tax to unearned income would change its nature, making it more of an income tax and raising questions about what kinds of income should be excluded, such as government benefits.

"There's a whole range of issues that exist on the income tax side that would come into play if you change the basis for the payroll tax," the aide said.

Orszag did not express an opinion on the idea.

If included, the new approach would allow the Senate to reduce or eliminate a proposed excise tax on high-cost insurance plans provided by employers.

Under legislation (S 1796) approved by the Senate Finance Committee, starting in 2013, individual insurance plans costing more than $8,000 and family plans costing more than $21,000 would face a 40 percent tax on the amount above that level.

Workers in high-risk professions and retirees who are not yet eligible for Medicare would get higher thresholds. Those thresholds would rise every year but not as fast as medical costs. The idea is to provide a strong incentive to contain costs; proponents argue that it's one of the provisions in the health care bills likeliest to make a difference in limiting health care inflation.

Economists expect that companies will reduce the generosity of plans to avoid the tax and share the savings with workers in the form of higher taxable compensation.

But Democrats, particularly those connected with organized labor, have been resisting the excise tax. They doubt that those wage increases will materialize and warn that the burden may fall on many middle-class families.

More than half of House Democrats have signed a letter urging that chamber's leadership to continue resisting the excise tax. The House bill (HR 3962) includes a 5.4 percent surtax on adjusted gross income above $500,000 for individuals and $1,000,000 for married couples.

Joseph J. Schatz, Alex Wayne and David Clarke contributed to this story.

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