Tax Analysts Blog

Sacrificing Tax Reform for Healthcare Reform

Posted on Jul 13, 2009

On caffeine and adrenaline, the White House staff is working 24-7 to keep the ambitious Obama agenda alive. Actor-economist Ben Stein worries this may not make sense: "We have an administration that is simultaneously seeking to end the recession, discussing drastic changes to laws on foreclosures and energy use and completely changing the health care system. I respectfully question whether all of this makes sense." Worse still, all that effort may not be working.

There are many indications the Administration's number one legislative priority may be in serious danger. The central conundrum is funding an enormous expansion of social services in the face of unprecedented government deficits. The original hope, that health cost savings could pay for a significant portion of expanded coverage -- or, even better, could help reduce the deficit -- are fading fast. The White House is publicly rebuking lawmakers for not incorporating cost saving reforms into their proposals. As David Broder reports Rep. Jim Cooper saying: the proposals under discussion "are weak on delivery system reform."

One way to pay for expanding healthcare coverage and providing much needed incentives to curb healthcare costs is to cap the amount of tax-free health benefits employees get from employers. Experts from both sides of the political spectrum are clamoring for this type of change. But last week, clearly under heavy pressure from unions, both Senate Majority Leader Reid and House Speaker Pelosi dismissed the idea. The Washington Post is right to complain:

The most sensible way to pay for expanded coverage -- taxing employer-provided health insurance -- also would help control costs. Taxing wages but not health insurance encourages more generous insurance benefits. Costs go up because there is more demand for services. It's mind-boggling that lawmakers continue to resist tapping this ready source of financing -- and doing good at the same time.

So without enough internal cost savings from the health delivery system itself, and without the political will to make obvious adjustments to healthcare taxation, what are we left with? The Obama administration suggested the sensible reform of scaling back the value of itemized deductions for high-income taxpayers. On Capitol Hill that idea was considered and rejected in about 15 seconds. How about a tax on "sugary drinks"? Or a tax increase on hard liquor? Too much well-organized, well-funded opposition for too little revenue.

This leaves the easy way out. Raising tax rates on the rich. Details are sketchy, but reports from the south side of Capitol Hill are that House Democratic leaders like the idea of a one-percent income surtax on the wealthy (i.e. income above $250,000) phasing up to 3 percent for incomes over $1 million.

A good working definition of tax reform (mine) is: an expansion of the tax base used to fund lower tax rates. Unfortunately, House Democrats are rejecting pro-tax reform proposals and adopting an anti-tax reform proposal in order to fund healthcare reform. Could this be a Democratic disease? In 1993, the Clinton Administration -- instead of doing the hard work of plugging loopholes to pay for deficit-reduction -- just waved its magic wand and raised tax rates. In contrast to the Democrats' penchant for undoing tax reforms, Republicans have a commendable track record. Reagan lowered rates and broadened the base (in 1986) and George W. Bush, despite all his other glaring faults, lowered tax rates (in 2001). Fortunately, the proposed higher tax rates will have a hard time making it past Blue Dogs in the House and an even tougher time in the Senate where some are still clinging to hopes of a bipartisan agreement.

The absolutely wrong way to increase taxes on the rich is by raising tax rates. Yes, it is probably a drag on economic growth, as conservatives argue, but more than that it creates an environment that is a breeding ground for tax loopholes, tax shelters, and offshore tax evasion. There's lots of tax breaks that should be eliminated, but Congress is viscerally incapable of pursuing that approach. It would mean challenging vested interests who will fight to the death because they are dependent on the tax code.

It is especially unsettling that House Democrats are pushing for higher rates while the Obama Justice Department is considering settling the UBS case in the middle of August when nobody is paying attention. Instead of putting a lid on offshore evasion, the Democrats in power are in danger of fanning the flames.

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