The Heritage Foundation

Executive Memorandum #180 on Taxes

November 2, 1987

November 2, 1987 | Executive Memorandum on Taxes

By Raising Medicare Taxes, The Senate Breaks the Promise of the1986 Tax Reform

(Archived document, may contain errors)

11/2/87 180


T he Senate Finance Committee last month approved an $11.6 billion tax increase package as par@ of its str ategy to cut the deficit. The central feature of the package is a sharp Medicare paroll taxes. The current Medicare tax is 2.9 percent of wages up to $43,800, and t is split between employee and employer. Under the Finance Committee tax hike, t he $43,800 cap would be eliminated. The 2.9 percent tax thus would be levied on all. eaimizigs without limit. 'Ibis would be a harsh and punitive tax increase on millions!of families above the current tax cap. Families at that cap already face a total pay r oll tax on- their employment of $6,260 this year. While employers supposedly pay half this tax, the fact is that the worker bears almost the entire amount. Because employers ;treat the tax as a payment for labor, they predictably and typically reduce wage s to make up for the payroll tax costs of hiring the worker. To the extent that employers bear the tax, it imposes a substantial burden on small and medium size businesses in particular. Increasing the tax would thus reduce the ability of these firms to cr e ate new jobs. The increase would also reduce the stock value of many businesses by reducing their profits, which could add further to the stock market decline. Payroll tax rates are already scheduled to rise next year under current law. With the Finance C o mmittee's tax hike, the total payroll tax, for a worker earning $60,000 in pre-tax wages would increase next year by about $900. Senate Np-FlopL The Senate Finance Committee proposal flip-flops on last yeaes tax reform compromise, under which tax rates we r e to be reduced sharply in return for the elimination of tax shelters and preferences. The chief focus of tax reform was to bring down the top marginal tax rate in return for fewer deductions. At that time, the payroll tax did not add to the top marginal r ate because it applied only to wages up to a maximum cap. By eliminating, this cap for the Medicare portion of the payroll tax, the Finance Committee I bill raises the top marginal federal tax rate by 2.9 percentage points, from 28 @ ercent to 30.9 percen t. p This violates the bargain that was the essence of last year's -tax reform package.

To make matters worse, the Finance Committee Medicare payroll tax is highly inequitable. Under Medicare, after all, workers all receive the same coverage and benefits . But with a 2.9 percent tax rate applied to all pre-tax wages, some workers would pay much more for the same benefits than others. For one worker, the total Medicare payroll tax could be $2,900 per year, while for another the total tax could be just $290 . When the government is providing a direct service to individuals such as health insurance, the most equitable financing is to chargei all the same amount for the same service, just as private life insurance or rivate health insurance premiums are the sam e regardless of income. Such Zancing is not a "regressive taie' but a proper, fair, and equal charge for equal service. Under the current payroll tax system, there is a degree of subsidy to those with, lower incomes, but the subsidy from higher income work e rs is limited by the tax cap. The Finance Committee's action would change this principle, treating higher income Americans merely as a "deep pocket." Penalizing a Minority. The Finance Committee bill thus would make Medicare extremely unfair for those wit h wages above the current taxable income cap. They would be charged much more for the same service than the others would be. Some proponents of the charge argue that the Medicare tax increase would apply only to about 10 percent of workers. But this seems t o suggest nothing more than a political calculation that Congress should penalize this group 'simply because it represents a minority of Americans. The Finance Committee bill would impose a harsh new. payroll tax that would mean hundreds of dollars per ye a r in new taxes for millions of American families. It would make Medicare into a new tool to soak better-off Americans instead of a self-financed health program, and it would be a dramatic betrayal of the most basic principles of the 1986 tax reform legisl ation.

Peter J. Ferrara 1 John M. Olin Fellow

F or further information: Peter J. Ferrara, "Upcoming Social Security Tax Hikes Can Threaten Retirement Benefits," Heritage Foundation Bad;grounder No. 597, August _% 1987. Peter J. Ferrara, "Averting the Medica re Crisis: Health IRAs," Cafo Policy Analysis No. 62, October 31, 1985.


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