Under Leader Reid’s amendment, in the year 2019 about 16 million U.S. citizens would be uninsured and be forced to pay a penalty tax of almost $800 per year. About eight million illegal aliens would be uninsured and would owe no penalty tax. Both groups would get their health care through a combination of out-of-pocket spending and use of uncompensated care in emergency rooms and free health clinics.

This seems unfair.

Details follow for those who care. Warning: the details get weedy quickly. You might want to skip them. I am including them mostly for experts and reporters who may want to follow up on this. If you are a policy amateur but have been reading this blog for more than a week or two, feel free to dive in. You can handle the complexity.

If you want to know my guess about why the Reid amendment has this problem, please skip to the last section of this post.

Background

Both the House and Senate bills require applicable individuals to buy health insurance. If you are an applicable individual and you do not have insurance, you pay a penalty tax to the IRS. The taxes are different:

• House bill: roughly 2.5% of adjusted gross income;
• Senate bill: $750 per person in 2016, with smaller phase-in amounts in 2014 and 2015.

Each bill defines exceptions to the term applicable individual. I will focus on the exceptions related to citizenship and presence in the United States.

Thanks to help from some smart friends, here is how I read the language:

Do the individual mandate and penalty tax apply?

This table is more complex than I would like, in part because of the different approaches in the two bills.

The key is the comparison of the two red cells. Under the Reid amendment, beginning in 2011:

• If you are a U.S. citizen living in the U.S. and you are uninsured, you pay the penalty tax.
• If you are illegally in the U.S. and you are uninsured, you do not pay the penalty tax.

In 2016 the Reid amendment’s penalty tax (with some exceptions) is $750 per person. It phases up from $95 in 2014 and $350 in 2015. By 2019, the penalty tax would be $794 per person (using CBO’s inflation assumptions.)

CBO says that, in 2019 under the Reid amendment there would be about 24 million uninsured people, “about one-third of whom would be unauthorized immigrants” (p. 8). So there would be about 16 M people in the Yes boxes, and about 8 M in the No box.

Legislative language

The key language is in section 5000(A)(d)(3), as would be added by section 1501(b) of the Reid amendment: “…

The following is from the Joint Tax Committee estimate of the revenue effects of the Reid bill. I have listed provisions with major revenue effects (+$20 B / 10 years) and a few others that have significant policy or political impacts. There are some smaller changes as well, which you can see for yourself in the 3-page document. All revenue figures are revenues raised over the ten-year period 2010-2019.

1. 40% excise tax on health coverage in excess of $8,500 (individuals) / $23,000 (families). Amounts are indexed for inflation by CPI-U + 1% … begins in 2013 … $149 B tax increase
2. Additional 0.5% Medicare (Hospital Insurance) tax on wages in excess of $200,000 ($250,000 for joint filers) … begins in 2013 – $54 B tax increase
3. Impose annual fee on manufacturers and importers of branded drugs … begins in 2009 … $22 B tax increase
4. Impose annual fee on manufacturers and importers of certain medical devices … begins in 2009 … $19 B tax increase
5. Impose annual fee on manufacturers and importers of health insurance plans … begins in 2009 … $60 B tax increase
6. Cut in half (to $500K) the amount of an executive’s compensation that a health plan can deduct from its corporate income taxes … begins in 2013 – $600 million tax increase
7. Impose 5% excise tax on cosmetic surgery and similar procedures … begins for surgery in 2010 … $6 B tax increase!

In total the bill would raise taxes by $370 B over ten years.

Here’s some reaction to these provisions. Updates since Wednesday night are in green.

Excise tax on high-cost plans (section 9001, beginning on page 1979)

It appears Leader Reid did, as rumored, raise slightly the limits in the Kerry excise tax on high cost plans, exempting some slightly more expensive health plans from taxation. It appears he substituted (2), the new Medicare payroll tax increase to cover the lost revenue.

The amounts in (1), relative to the Finance Committee, look like the result of an aggregate constraint from the unions. The Baucus / Finance Committee bill had limits of $8K / $21K and raised $201 B. The Reid limits of $8.5K / $21K are only slightly different, but raise $149 B. It looks like someone said “Get the Kerry tax number down from $200 B to under $150 B.”

From my perspective, this is crazy. Reid and Senate Democrats now have to defend themselves on two major tax increase policies rather than one. If you’re going to take the political hit for the Kerry tax on high cost plans, you might as well squeeze as much revenue as possible out of it. I assume he did this because someone forced him by threatening to oppose the bill (unions? one or more Senators?).

Medicare payroll tax increase (section 9015, beginning on page 2040)

Wow. It’s incredible that a Democratic leader would propose this.

Current law:

• Wages up to $106,800 in 2009 (and in 2010) are subject to payroll taxes of 15.3%: 12.4% Social Security + 2.9% Medicare.
• Wages above $106,800 are subject to payroll taxes of 2.9%.

My reading of section 9014 of the bill tells me that Leader Reid proposes the following addition (changes in red):

• For individuals, wages between $106,800 and $200,000 for individuals are subject to payroll taxes of 2.9%.
• For individuals, wages above $200,000 are subject to payroll taxes of 3.4%. That’s a 0.5 percentage point tax increase. So for each $1K you make above $200K, you would pay $5 more in payroll taxes.
• For joint filers, wages between $106,800 and $250,000 for individuals are subject to payroll taxes of 2.9%.
• For individuals, wages above $250,000 are subject to payroll taxes of 3.4%. That’s a 0.5 percentage point tax increase. So for each $1K you make above $250K, you would pay $5 more in payroll taxes.
• These threshold amounts of $200K and $250K are not indexed for inflation or wages, so more real income in each subsequent year will be subject to the 0.5 percentage point tax increase.
• The additional 0.5 percentage point tax increase comes on the employee side, so you still pay income taxes on these additional amounts of taxes paid.

With this proposal, Senator Reid is leading Democrats across a major philosophical threshold. Since Social Security was created in the 30’s and Medicare in 1965, payroll tax revenues have been “dedicated” to financing these programs. While not all funding to finance Medicare comes from payroll taxes, all funding from the Medicare payroll tax finances Medicare. In other words, the 2.9% Hospital Insurance payroll tax that you and your employer pay on your wages is all supposed to offset Medicare spending. That is part of the social insurance model, in which everyone pays in a fraction of their wages, and everyone receives benefits later.

I am not a fan of the social insurance model, because it is non-transparent: most people think their individual taxes paid are being used to finance their benefits, when in fact the funds are used to subsidize other people’s benefits. But the social insurance model and dedicated payroll taxes have been a core principle of Social Security and Medicare financing since they were created, and advocates (especially on the Left) of those programs have fiercely defended this principle.

Leader Reid’s bill would use new Medicare payroll taxes to finance a new health entitlement outside of Medicare. His bill would turn Medicare payroll taxes into a general financing mechanism like the income tax. There is a slippery-slope argument against this that I would normally expect from the Left. If Republicans (or my former boss) had proposed this, I would expect AARP to come unglued and raise fears among seniors that, if this proposal becomes law, future Congresses might take payroll tax revenues and use them for highways or defense or other non-social insurance spending. I am interested to see how AARP reacts. Will they support the Reid bill as they did the House bill? (Reporters: There’s a story for you. Ask AARP.)

In addition, Social Security and Medicare payroll taxes have always worked from the bottom of the wage scale upward, because they are traditionally tied to benefit eligibility. Leader Reid is now creating a “donut hole” in which there are three rate “brackets.” This initiates and lays the groundwork for the future expansion of a progressive tax rate structure for payroll taxes. This makes it easier for future lawmakers to raise payroll taxes to finance other parts of government, because they’re just “taxing the rich.” While the Reid proposal applies only to wages at the top of the distribution, the principle would be in place to justify raising payroll taxes in that $106K – $200K in the future. Watch out.

Both of these are enormous precedents, long-term structural game changers in how we finance our government.

The non-indexing for inflation raises an interesting question about whether it breaks President Obama’s pledge. Was his $250K limit in real or nominal dollars?

This provision is a big risk for moderate Senate Democrats.

Tax experts – it looks like they’re doing something tricky by using “taxpayer” rather than “individual” as in section 3101(b) of the I.R.C. I invite further explanation if this is significant.

Taxes on branded drugs, medical devices, and health plans (section 9008 on page 2010, section 9009 on page 2020, and section 9010 on page 2026)

The drug tax is a tax on “Big Pharma.” Bigger drug companies would pay higher taxes. For instance, a branded drug company with sales of $5M – $125M would pay taxes on only 10% of its gross sales, while one with >$400 M of sales would pay taxes based on 100% of its gross sales. (See p. 2012 of the bill.)

It is also applied only to brand name drugs, not generics. I would like to hear the policy rationale for this. The political rationale is simple: shaft the big brand-name Pharma companies. With exceptions, brand-name drug companies generally lean R, generic drug companies generally lean D.

In each case, I expect the providers will pass most of the tax increase on to consumers in the form of higher prices.

There are also a bunch of reporting requirements that at first glance look as if they are laying the intellectual groundwork for the future imposition of price controls. I invite further explanation from someone with expertise in drug pricing and rebates.

I know of no legitimate policy rationale for any of these taxes. They are derived from the following logic:

• If the government spends more on health insurance, these two industries would make more money.
• The government needs tax revenues.
• So we’ll tax these industries to capture some of their increased revenues.

Shafting the health plan executives (section 9014 on page 2035)

I’m torn between hating the policy and chuckling at the political naivete of leaders of the health insurance industry. Unlike the taxes on big Pharma and medical device firms, here Leader Reid is going after the health plan executives’ individual compensation. He’s making it more expensive for a health plan to pay its executives more than $500K. Note that the higher taxes would apply to income earned paid in 2013 or later, even if that income was earned as early as 2010.

It’s terrible policy to single out the compensation of any particular industry. Wall Street: if this becomes law, you’re next in the crosshairs.

This is gratuitous political punishment of an unpopular constituency. The section is titled “Limitation on excessive remuneration paid by certain health insurance providers.” It raises $600 M over 10 years, and is thus insignificant as a pay-for.

How’s that political alliance working out for you guys?

Rather than trying to repeal this section, I’ll bet some creative Republican Senator offers an amendment to extend it to trial attorneys involved in medical malpractice cases.

Cosmetic surgery tax (section 9017 on page 2045)

The federal government would impose a 5% sales tax on cosmetic surgery. Late-night comedians will love this.

I can’t think of another case where the Feds would impose a sales tax. Governors and Mayors usually regard sales taxes as “their turf.” I wonder if they’ll fight this.

Update: Best guess is that it does not apply to braces, but would apply to teeth whitening.

Joint Tax estimates this new tax would raise $5.8 B over ten years. That’s a lot of cosmetic surgery.

This tax would violate the President’s pledge not to raise taxes on those with annual income below $250K.

It would apply to surgery performed beginning in 2010, so get your work done before the new year.