Health Surtax Stokes Up Ideological Debate In Washington

by Mike Godfrey, Tax-News.com, Washington

21 July 2009

An ideological split has emerged in Washington over proposals for an income ‘surtax’ to pay for President Obama’s health care reforms.

On the left of the debate, the Congressional Democrats argue that America’s wealthier taxpayers should contribute a small part of their income to allow the vast number of uninsured Americans to have access to affordable healthcare. On the right, Republicans and free marketeers contend that the proposals will increase the tax burden on small businesses – the backbone of the US economy – during a recession, force marginal income tax rates in some states above 50% and generally represent an ‘un-American’ solution to the healthcare dilemma.

The America’s Affordable Health Choices Act of 2009, which was approved by the House Ways and Means Committee by a vote of 23-18 on July 17, would impose a surtax of: 1% on married couples with adjusted gross incomes between USD350,000 and USD500,000 (singles between USD280,000 and USD400,000); 1.5% on couples with incomes between USD500,000 and USD1 million (singles earning between USD400,000and USD800,000); and 5.4% on couples earning more than USD1 million (singles beyond USD800,000).

“This is an exciting day in the history of this Committee and the Congress as we tackle the challenges of reforming America’s health care system,” enthused Ways and Means Committee Chairman Charles Rangel (D-NY). “America is ready for reform, the rising cost of health care has been draining the economy and the pocketbooks of American families for too long.”

A Ways and Means summary of the proposals, based on Congressional Budget Office estimates, claims that 98.8% of US households would remain unaffected by the surtax and, at worst, those liable for it would have to contribute no more than 0.9% of their annual income.

Much of the debate, however, is focusing on the impact of the proposals on small business owners – the “real victims” of the surtax, according to the US Chamber of Commerce.

“We need policies that help small businesses not harm them," said Chamber President and CEO Thomas J. Donohue.

"Placing a big tax burden on the small business community would rob them of the resources they need to create the jobs that will lead us out of the recession," he added. "Since when does our great free market country punish success? If there's one sure way to kill the goose that lays the golden egg, this is it."

House Democrats say that the surtax would affect only 4% of all small business owners – most of whom pay income tax at their individual marginal rates - even using the broadest definition of the term, i.e. any individual earning as little as a dollar in business income.

A memorandum released by Republican tax counsels in response to the proposals, unsurprisingly, disputes the Democrats’ calculations. “The affected business activity and workers are not proportionate to the percentage of small businesses affected. That’s the key flaw in the proponent’s argument,” the memo states.

Citing figures from the National Federation of Independent Business (NFIB), the Republican analysis says that taxpayers above USD250,000 in income account for “significant ownership” of small businesses. Based on this assumption, for firms with 1-9 workers, the ownership percentage is 6.4%; for firms with 10-19 workers, the ownership percentage is 21%; for firms with 20- 249 employees, 40% of owners earn $250,000 or more.

Furthermore, Republicans say that data from the Joint Committee on Taxation shows that at least 55% of the revenue raised by President Obama’s proposal to increase the top two marginal income tax rates from 33% and 35% to 36% and 39.6%, respectively, in 2011 comes from small business income.

A recent study by the Tax Foundation shows that the health surtax will push the top marginal tax rate over 50% in 33 states.

"More than three-quarters of the states would face combined top income tax rates exceeding 50% under this latest health care funding proposal," Tax Foundation President Scott Hodge said. "That means government would be taking more than half of every additional dollar from high-income taxpayers. The lowest top tax rate would be about 47% — and that's in the nine states that don't tax wages."

The hardest-hit states would be Oregon (57.5%), Hawaii (57.2%), New Jersey (57.1%), New York (56.9%), California (56.8%), Rhode Island (56.2%), Vermont (55.8%), Maryland (55.6%), Minnesota (54.4%) and Idaho (54.3%). Washington, DC, and New York City would see their top effective marginal rates rise to 55.0% and 58.7%, respectively. The effective marginal tax rate takes into consideration deductions and adjustments in order to present a truer measure of an individual's rate. Top tax rates in the remaining 11 states range from 47.3% to 50%.

“This latest tax scheme would drive the top rates in the US to among the highest in the industrialized world, leaving economic havoc in its wake,” wrote Brian Riedel and Cutis Dubay in a critique for the Heritage Foundation. “Congress should seriously consider the consequences of such a policy.”

“This should finally put to rest President Obama's implausible claim that expanding government health care benefits will save money, since policies that save money do not typically require painful tax increases to offset their cost,” the added.

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