Unwise to Tax the Rich to Pay for Health Care

by: Ryan Avent

Democratic leaders were very pleased to see the latest Congressional Budget Office scoring of the House of Representatives health insurances reform package. After running the numbers, the CBO determined that the measure would cost $1 trillion over ten years and would result in nearly all Americans being covered. A pretty good deal, most agreed.

And yet, coming up with $1 trillion in new revenue is still a challenge, but it's one legislators seem to have met. After considering a number of potential revenue raising measures—from a Value-Added Tax to new levies on unhealthy food and beverage items—lawmakers turned to the most reliable source of funds: the rich.

House leaders have unveiled a new surtax proposal, which essentially creates three new upper income tax brackets that will be charged a surtax beginning in 2011, which will increase in 2013 if expected cost saving measures in the bill don't work out. The initial surtax rates are 1% for households earning from $350,000 to $500,000, 1.5% for those earning from $500,000 to $1 million, and 5.4% for households earning over $1 million per year. These are marginal rates, so a household earning $400,000 would pay $500 in additional taxes—1% multiplied by the $50,000 in income above the $350,000 threshold. A household making $1 million in a year would be responsible for an additional $9,000 in taxes. In all, 1.2% of American households will be affected.

What to say about this? Well, it's a shame that Congress missed out on opportunities to use more efficient taxes. And while those of us comfortably under the surtax threshold may roll our eyes at an additional $9,000 burden for a family earning $1 million in a single year, these measures will probably act to discourage some economic activity among high earning families. Greg Mankiw estimates that for top earners, this may push the total tax burden to near 55%—not awful by either European or historical standards, but not ideal, either.

For me, the biggest concern is that Congress seems to have followed the path of least resistance here and it may do so again in the future. Recall that America has a fairly significant structural deficit, which will only grow as the population ages. America also has fairly significant need for large-scale investment in things like infrastructure and education. Revenues are going to have to rise to avoid a budget crisis somewhere down the road. And that means that taxes will have to rise.

It would be extremely unwise to try and stick all of the additional tax burden on the rich. Unnecessary, too—there are many opportunities out there to tax negative externalities, and the use of a broadly shared tax burden to fund fairly progressive social safety nets in Europe seems to work well. It's a lot easier to raise taxes on 1.2% of the population than on the majority, but that's a game which begins to have diminishing returns very quickly. There are ways to raise revenues without placing a very large drag on economic activity, and Congress needs to figure out how to find the political mojo to make it happen.

This article originally appeared on The Economist.com