The Health Care Bill: Disaster for the Economy

“To Hell With the Economy”
Tony Lima
March 23, 2010

By 1935, the U.S. economy was on the road to recovery from the Great Depression (1930 – 1940).  But two forces kicked the upturn off the track.  First, the Supreme Court declared many of President Roosevelt’s programs unconstitutional.  While a number were reconstituted, the National Recovery Administration (NRA, no relation) remained dead.  Second, after 1936 the only new law enacted left standing was the Fair Labor Standards Act, setting maximum working hours and minimum wages.

Not surprisingly, that intervention in labor markets led to a second dip for the economy.  In order to defeat the Conservative Coalition, President Roosevelt moved to the left and accommodated the unions.  The result was four more years of the Great Depression.

Fast forward to 1966.  President Lyndon Johnson decides to fight two wars at the same time: Vietnam and the War on Poverty.  Since Vietnam was politically unpopular he decided not to raise taxes to pay for these ventures.  According to legend, his economic advisers told him those policies would wreck the economy.  Johnson’s reply: “To hell with the economy.”  Result: the beginnings of the inflation and unemployment that plagued the 1970s.

So here we are 45 years later.  The economy is in a deep recession.  If we’ve learned one thing since John Maynard Keynes published The General Theory of Employment, Interest, and Money (1936) it’s this: don’t raise taxes during a recession.

Yet that’s exactly what the recently-passed health care bill does.  To support the accounting fiction that the government budget deficit will be reduced, many of the taxes and fees begin during the next two years. The majority of benefits don’t kick in until 2014.  Is this yet another instance of presidential ego trumping sound economic policy?

As of March 27, various corporations have announced they will recast their earnings to reflect the fact that healthcare prescription benefits offered under their employees’ insurance plans will no longer be tax deductible.[1] According to the Wall Street Journal article cited in the footnote, “Mr. Zion of Credit Suisse estimated in a report this week that companies in the S&P 500 index will rack up a combined $4.5 billion charge due to the change in the value of the tax asset.”  That’s the equivalent of a $4.5 billion tax increase.

Let’s consider another small part of the new taxes.  Beginning in 2012[2] there will be additional taxes imposed on individuals with wage income over $200,000 ($250,000 for married couples filing joint returns).  There are two parts to these taxes.  First, an additional tax of 0.9% will be levied on wages and salaries in excess of $200,000 ($250,000).  Using IRS data for 2007[3] together with some educated guesses, total income above $200,000 was about $1,382,126,976,000.[4] That implies a tax increase of about $12,439,000,000.

The second tax extends Medicare taxes to cover “Modified Gross Income.”  This is defined in the legislation as

“gross income–

‘(i) decreased by the amount of any deduction allowable under paragraph (1), (3), (4), or (10) of section 62(a),

‘(ii) increased by the amount of interest received or accrued during the taxable year which is exempt from tax imposed by this chapter, and

‘(iii) determined without regard to sections 911, 931, and 933.”[5]

Basically, modified gross income is wages and salaries plus interest.  The phrase “exempt from taxes” refers to the exemption of non-employment income from Social Security and Medicare taxes.  The purpose of this clause is to extend the 3.8% Medicare tax to cover all interest earned by anyone making over $200,000 ($250,000).

Interestingly, the Joint Committee on Taxation (JCT) uses a different definition of modified gross income.  JCT includes “investment income for taxpayers with AGI in excess of $200,000/$250,000 (unindexed).”[6] As far as I can tell, JCT is including both interest and ordinary (non-qualified) dividends.  For the year 2007, that total for households with income above $200,000 was $196,513,160,000.  The total tax increase for that year would have been $19,906,642,864.  Call it $20 billion, bringing the total tax increase to $32 billion.

Before looking at the implications of this, note that Congress has effectively passed an additional Alternative Minimum Tax.  Since the income limits are not indexed for inflation, over time a larger percentage of the population will exceed those limits.  Bingo!  Real income growth and inflation will both push more households into this group.  Sure enough, the JCT forecasts revenue from this source to rise from $20.5 billion in 2013 to $38.3 billion in 2019.  Unfortunately JCT has not yet released their methodology, making it impossible to verify how much of this increase is caused by more households rising into this income category.

Let’s take a quick example.  Suppose a married couple earns exactly $250,000 in 2012.  They have interest income of $3,000 from certificates of deposit.  In 2013 their income rises to $250,001.  For that extra dollar of income they will pay 0.9% of $1 or about a penny.  BUT they will also pay 3.8 percent of the entire $3,000 or $114.  Talk about a high marginal tax rate – this is about 11,300 percent!

Some of these folks are lucky.  They run family-owned businesses.  My tax advice would be to immediately hire all family members over the age of 18.  Make sure none of them earn over $250,000.  If you are single, consider adoption as a tax strategy.  If you are married, consider divorce so that each of you can claim income of $200,000.[7]

A somewhat more serious proposal is to begin shifting your portfolio into tax-exempt securities.[8] Many people are likely to do this.  The effects are straightforward.  An increase in demand for municipal bonds will drive muni prices up and yields down.  State and local governments will pay less for borrowing.  At the same time the demand for corporate bonds will fall, driving their prices down.  Corporations will pay higher interest rates.

One potential benefit from this is a possible shift from ordinary dividends to qualified dividends.  According to IRS publication 550, for dividends to be qualified the stockholder “must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date,”  Presumably one positive effect of this law will be to encourage longer holding periods for stocks – although 60 days isn’t all that long. [Correction per several correspondents: the tax rate on qualified dividends is 15% if your federal tax bracket is above 15%.  And all this becomes irrelevant as of Dec. 31, 2010 when the Bush tax cuts pretty much evaporate.]

What’s very likely is that the 3.8% tax on interest won’t raise much revenue – far less than JCT estimates.  People in this income category can manage their wealth.  They will shift assets out of securities paying either interest or ordinary dividends.

But, what the heck.  Let’s go with the JCT and CBO numbers.  The total tax increase is $4.5 billion this year (business profits fall) plus $32 billion in 2013.  Using a tax multiplier of 1.5 I expect real GDP to be about $6.75 billion lower in 2010 and $48 billion lower in 2013.  Real GDP for 2009 is estimated as $12,987.4 billion, a decrease of $324.8 billion from 2008.[9] Tacking a few more billion onto those negative figures is not a real good idea.

My conclusion is simply this: despite the fiscal stimulus (much of which still remains unspent[10]), the U.S. economy will continue in recession through 2013.  At best we can expect sluggish growth.  The tax increases in the health care bill combined with the expiration of  many of the Bush tax cuts in 2011 are two factors.  But there’s even more.  Fiscal policy is as much about expectations as actual changes in tax rates and government spending.  Right now businesses and individuals expect higher taxes to continue for the duration of the current administration.  Therefore I expect the recession to continue at least until November, 2012 and possibly even longer.

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[1] The reality is actually more complicated than this simple statement.  In fact, the corporations were receiving a subsidy for these benefits.  For reasons known only to Congress and the IRS this subsidy was a deductible business expense.  Under the health care bill the deduction goes away.  A semi-coherent explanation is in the Wall Street Journal: “AT&T Joins in Health Charges,” March 27-28, 2010, p. A1.  As of March 27, 2010 this article is available at http://online.wsj.com/article/SB10001424052748704100604575145981713658608.html?mod=WSJ_hps_LEFTWhatsNews

[2] According  to JCT, these taxes begin 12/31/2012.  However, mysteriously the taxes generate $1.3 billion in 2012.  In 2013 the JCT estimate is $20.5 billion.
See http://www.jct.gov/publications.html?func=startdown&id=3672.   Accessed March 22, 2010.

[3] http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96981,00.html.   Accessed March 22, 2010.

[4] The IRS only reports an income range from $200,000 to $500,000.  The income figure is my best estimate.

[5] http://www.opencongress.org/bill/111-h3590/text.   Accessed March 21, 2010.

[6] http://www.jct.gov/publications.html?func=startdown&id=3672.   Accessed March 22, 2010.  See item 15 under “Revenue Provisions.”

[7] Some of us are old enough to remember when the U.S. marriage tax penalty was so high that some couples paid for a nice vacation to Mexico by getting divorced in December, then getting married again in January.  The new health care law will undoubtedly cause similar behavior.

[8] The JCT appears to implicitly assume this as their estimate of tax revenue falls from $20.5 billion in 2013 to $16.6 billion in 2014.

[9] http://bea.gov/national/index.htm#gdp.   Accessed March 27, 2010.

[10] http://www.propublica.org/ion/stimulus.  As of March 27, 2010, $228 billion of the $581 billion total stimulus spending remains unspent. An additional $93 billion in tax cuts have not been used.