Taxing investments to pay for healthcare reform is a bad idea

January 14, 2010

Labor unions are balking at President Barack Obama’s move to pay for healthcare reform by taxing their gold-plated health benefits. So Democrats are considering also taxing investment income. Not only would that approach make reform more costly and potentially worsen the U.S. fiscal deficit, it could politically doom the whole plan.

As things stand, the year-end expiration of the 2003 Bush tax cuts means top rates on capital gains and dividends automatically rise unless Obama and congressional Democrats intervene. Now, in addition to that, if organized labor prevails in killing a plan to slap a 40 percent excise tax on its members’ pricey health plans, investors can expect to tack on an additional one or two percentage points. That would push the peak cap gains rate to 22 percent and dividends to 42 percent.

To appease these powerful special interest groups some congressional Democrats suggest for the first time extending a portion of the current 3 percent Medicare payroll tax on labor income to investment income for individuals making $200,000, a group that pays some 80 percent of investment taxes. With this source of revenue – perhaps $10 billion a year or more — the tax on union health plans could be scaled way back.

Setting aside the negative impact this could have on the formation of risk capital and savings more broadly, a health plan tax is a key mechanism for controlling rising costs. Expensive and untaxed health plans encourage overconsumption of healthcare. Arguably all deductions for health benefits should be removed to eliminate this distorting subsidy.

Taken as a whole, new investment taxes run the risk of weakening Senate support for reform – the loss of even a single vote would be lethal — since the upper chamber has shown little interest in new taxes on capital. Coming at a time when Americans’ net worth has fallen $11 trillion, it shouldn’t be hard to find one principled Senator willing to quash this misguided attempt to succor labor at the expense of investors.

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