Patient CARE Act Would Impose 37 Percent Marginal Income-Tax Hike on Late Middle-AgedJohn R. Graham • Tuesday February 4, 2014 12:11 PM PST •
I have already written twice about three Republican Senators’ health-reform bill (here and here). Nevertheless, it continues to attract attention, and its likely most curious impact has not yet been described. The Patient CARE Act, put forward by Senators Hatch, Burr, and Coburn, would institute changes to marginal-income tax rates that would increase disincentives to work for some, especially those in prime earning years.
One problem with the American welfare state is that it imposes high effective marginal income-tax rates on people at low incomes. Economists describe these as “notches” or “cliffs,” and Obamacare is stuffed with them.
Casey Mulligan of the University of Chicago recently produced an analysis showing how Obamacare increases marginal income taxes across the income spectrum. Mulligan’s analysis is technically complex. A more accessible analysis was written by Michael Cannon of the Cato Institute before the bill was passed.
Obamacare is a nasty tangle of tax hikes, as well as subsidies for premiums, co-pays, and deductibles. Cannon showed that it imposes marginal-income tax rates ranging from about 70 percent to 80 percent on families of four that earn between about $30,000 and $90,000. This means that if a family gets a raise of $1,000, it will lose $700 or $800 of Obamacare benefits. For some individuals, Cannon showed that Obamacare imposes marginal income-tax rates of over 100 percent. (A more recent paper by Ed Haislmaier of the Heritage Foundation details how Obamacare benefits phase out as household income rises.)
The Patient CARE Act subsidizes the purchase of health insurance differently than Obamacare does, but introduces a new twist: Subsidies for low-income families increase with age. For a family whose head is between age 18 and 34, the annual subsidy would be $3,400. For a family whose head is between age 35 and 49, the annual subsidy would be $6,610. For a family whose head is between age 50 and 64, the annual subsidy would be $8,810.
While this makes sense with respect to average expected health costs, it wreaks havoc with marginal income-tax rates. Specifically, those in late middle age suffer a significant disincentive to increase their employment earnings.
The subsidy phases out between 200 percent and 300 percent of the Federal Poverty Level (FPL). This means that if the Patient CARE Act had been law in 2013, a family (with two adults and two kids) headed by a baby boomer that earned up to $47,000 would have received a $8,8100 subsidy for qualifying health insurance. This would phase out to zero at $70,600. The $8,810 subsidy declines in a straight line with income.
Ignoring all other tax effects (statutory income tax changes, FICA taxes, et cetera), this implies a marginal tax rate of 37 percent for every pay increase within the range.
The subsidies change with age, but the FPL income cut-offs do not. So, because the younger families get lower subsidies, they do not face the same high marginal income-tax rates. For the family headed by a middle-aged person, the marginal income-tax rate is only 28 percent. For the younger family, it is only 14 percent.
On balance, I expect effects of marginal income-tax hikes would be much less harmful under the Senate Republicans’ Patient CARE Act than under Obamacare. However, the bill does contain significant disincentives to increasing household income, especially for those in late middle age.
A solution to this would be an age-adjusted tax credit that does not phase out with age, which would require a much greater change in the tax treatment of employer-based health benefits than proposed in the Patient CARE Act.
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For the pivotal alternative to Obamacare, please see the Independent Institute’s widely acclaimed book: Priceless: Curing the Healthcare Crisis, by John C. Goodman.