Taxing the Rich: The (Politically) Smart Way to Pay for Health Care

The big news on the health care front this weekend is that House Democrats are prepared to call for a tax increase on the highest-earning Americans in order to pay for expanded health insurance. Although accounts of the exact details differ slightly, it appears that the tax hike would take the form of a "surcharge" of 1 percent on incomes from $280,000 to $400,000, 1.5 percent on incomes of $400,000 to $800,000 and 3 percent on incomes of $800,000 and above. This means that someone making $500,000 would pay about an extra $2,700 in taxes each year, and someone making $1,000,000 would pay an extra $13,200. The burden, in other words, would fall disproportionately on those who earn not just in the six figures, but rather in the seven figures, for whom much more of their income would become subject to the 3 percent rate.

I applaud the House for recognizing that the world doesn't end at $250,000 or $357,700 (the beginning of the top marginal income tax bracket as of last year). Throughout most of American history before Reagan, the top tax bracket kicked in at figures much higher than $357,700 in today's income: the equivalent of about $75 million in today's dollars, for example, during portions of FDR's presidency.

I also think the House has probably found the path of least resistance in terms of marshaling public support for financing health care. In June, the Kaiser Health Tracking Poll asked Americans about seven different mechanisms to pay for health care. The one solution that Kaiser missed was that of a national sales tax, so for that I use data from Rasmussen Reports instead, who ran a May poll indicating that 40 percent of Americans would support a national sales tax if it paid for health insurance. Increasing taxes on incomes of $250,000+ was supported by 68 percent of Americans in the Kaiser poll, tying it with increased cigarette and booze taxes for the most popular option:



Why pick the income tax hike rather than higher cigarette and alcohol taxes, which are just as popular? For one thing, it's not clear that higher cigarette and alcohol taxes alone would be enough to finance health care; they were generally being considered along with other funding mechanisms. For another, alcohol and particularly cigarette taxes would be quite regressive. For a third, we have to consider the political fallout from a tax once it actually hits taxpayers, and not just when it's in the proposal phase. Joe Six Pack might not think it's a horrible idea in the abstract to increase the price of beer, but when he's actually paying extra for his case of Michelob Ultra, he might not be so happy about it.

We should point out that raising taxes on the wealthy is probably not the most economically sound way to pay for health care, which would be to limit or remove the benefits tax exemption and tax benefits like all other types of earned income. This alternative, however, is considerably less popular and is opposed by many unions, who have generally negotiated very attractive benefits programs for their employees. In a perfect world, of course, these things wouldn't be mutually exclusive: you could remove the benefits tax exemption and make the tax code more progressive. But practically speaking, trying to do both those things might just give more people a reason to be unhappy. The surcharge proposed by Charlie Rangel and the House Democrats at least has the benefit of being simple.

The one thing the Democrats ought to be aware of, however, is that if this proposal is passed, it will probably become more difficult later on to repeal the Bush tax cuts for high-income earners. Raising taxes is always difficult, and I'm not sure the Democrats will get more than one bite at the apple, at least until/unless Barack Obama is re-elected in 2012 and has some fresh political capital. But this proposal, overall, is probably more attractive than repealing the Bush tax cuts, since it focuses more of the burden on $800K+ earners.

I'd expect the Republicans to begin arguing more vociferously that the right way to pay for health care is indeed to remove the benefits tax exemption. As I mentioned, they are on somewhat solid economic grounds for doing so. In reality, however, removing the benefits tax exemption is more of a political poison pill, a fairly unpopular policy which the Democrats would probably be blamed for later on.

Whether the Democrats can get enough Blue Dog votes to pass health insurance is another matter. The Blue Dogs tend to be split into two camps: the populist Blue Dogs, who usually hail from rural areas, and who are generally somewhat socially conservative but more economically liberal; they will probably have no great problems with this. Then there are the corporatist Blue Dogs, who tend to represent wealthier, suburban districts and are more libertarian in their ideology. Some resistance from that latter group is likely, although that would probably be the case regardless of what mechanism was selected to finance health care.

The bottom line is that the House wants to pay for health care in a way that almost 7 in 10 Americans can live with. That doesn't mean its passage is going to be easy -- but the bill won't fail for its lack of public popularity.