Economics, Taxes and Spending

Tax on Income Earned by Savers Signed Into Law

savingsToday, President Obama signed into law the second healthcare bill, the one adopted through the budget reconciliation process. Among many other provisions, the bill imposes a new 3.8 percent tax, starting in 2013, on certain investment income received by households with incomes above $200,000 ($250,000 for couples). This tax, which was not in the House or Senate healthcare bills, was adopted without any congressional hearings and with little public debate. Earlier this month, Amy Roden and I discussed how the tax, then expected to be imposed at a 2.9 percent rate, is likely to impede economic growth.

The new law places the investment tax provisions in new Chapter 2A of the Internal Revenue Code, which is captioned “Unearned Income Medicare Contribution.” This four-word caption achieves the startling feat of being misleading or incorrect in three separate ways.

First, the tax will have only a tenuous link to Medicare. To be sure, its proceeds will be earmarked to the Medicare Part B trust fund that finances outpatient care. Because Congress has already given this trust fund unlimited authority to draw on general revenues, however, this earmarking will not increase the amount of money available to the Medicare Part B program. The impact on the allocation of federal resources will be no different than if the proceeds were paid into the general treasury. Although not completely incorrect, the caption’s reference to Medicare is misleading.

Second, the tax will not apply to “unearned income,” but to income earned by savers who defer consumption and thereby provide resources for business investment. (Unfortunately, this mislabeling is not a new feature of the Internal Revenue Code. A number of past and present provisions, including those pertaining to the earned income tax credit and the foreign earned income exclusion, use the term “earned income” to refer only to income earned by workers and not to income earned by savers.) Congress’s failure to recognize that income from saving is a form of earned income has disquieting implications for its future policy decisions.

Third, the new levy will not be a voluntary “contribution” offered by the affected households, but will instead be a tax payment compelled by law. (The mislabeling of taxes as contributions is also not new; Chapter 21 of the Internal Revenue Code, which pertains to Social Security and Medicare payroll taxes, is captioned “Federal Insurance Contributions Act.”) The legislative language within the new chapter is more candid than the caption, consistently referring to the levy as a “tax.” Certainly, any affected household that chooses not to make this “contribution” in 2013 will quickly learn that there is nothing voluntary about it.

Amending or repealing the new chapter’s substantive provisions would promote economic growth. As a modest first step, though, consideration should be given to amending the caption. Changing it to “Tax on Income Earned by Savers” would be a small victory for transparency in tax policy.

UPDATE: In my original posting, I understated one of my points, because I overlooked a last-minute change to the bill. In reality, the reference to “Medicare” in the caption of Chapter 2A is entirely false, rather than merely misleading. Although the bill originally included a provision earmarking the proceeds of the tax to the Medicare Part B trust fund, that provision was removed prior to passage of the bill. Under the final version of the law, the tax proceeds are simply paid into the general treasury. The “unearned income Medicare contribution” therefore has no Medicare link at all.

Image by Alan Cleaver.

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