The worst idea candidate Barack Obama had during the presidential campaign was his pledge to finance health reform with taxes on capital. To be fair, he didn't word it that way. Instead, he promised to pay for universal health care in part by rescinding George Bush's "tax cuts for the rich."
Bush didn't cut taxes for the rich, however. He lowered the tax rate on capital gains income and substantially lowered the tax rate on dividend income for all taxpayers, many of whom have high incomes. Bush also lowered the top rate on wage income; but for high-income earners this is also frequently income from capital (pass-through profits to owners of small businesses, for example).
Obama is now proving that he keeps his word and then some. Overall, his new budget includes a slew of new taxes on businesses and investors totaling almost $1 trillion over the next 10 years (and that doesn't even count the $646 billion "cap and trade" tax). He proposes to "bank" a portion of this for health care to be matched by difficult-to-make health care spending cuts and by health care "savings" that virtually all independent analysts agree are unlikely to materialize. The only thing certain so far is the taxes.
What's wrong with paying for health reform by taxing investment income? It is always bad to tax capital to pay for consumption. Capital is the seed corn that grows businesses, creates jobs and generates the income that makes consumption possible. Taxing capital to pay for health care consumption is especially bad, considering that health care spending at the margin is already very wasteful.
In his proposed budget, Obama proposes to sequester $318 billion for health care reform over 10 years — not from capital gains or dividend taxes, but from revenue produced by new limits on itemized deductions for those with incomes of $250,000 or more. This doesn't sound as bad as raising taxes on investment income, but those tax breaks are in the budget, as well. Since tax dollars are fungible, it really doesn't matter which revenue dollars are targeted to pay for which spending program. The damage is the same, regardless of the labeling.
Strangely, while restricting what Bill Gates and Warren Buffet can deduct for mortgage interest and charitable gifts, Obama would leave them free to spend an unlimited amount on health care — all of it subsidized by Uncle Sam.
Given a combined federal and state tax rate of close to 50 percent, Bill Gates (through Microsoft) will be able to continue to buy health insurance at 50 cents on the dollar. This means his incentive is to buy coverage until its value to him is about half of what it really costs. Then, because the tax system subsidizes third-party insurance relative to self-insurance, he will likely have the kind of insurance that leaves him with few out-of-pocket costs. At the national average of only 12 percent of health care spending out of pocket, Gates will have an incentive to consume health care until its worth to him only 12 cents on the dollar.
The Obama administration has released no specifics on what a detailed health reform plan would look like. But if it is anything like what candidate Obama talked about on the campaign trail, it will ignore other commonsense incentives, from top to bottom.
For example, candidate Obama threatened a pay-or-play mandate on employers that would compel them to provide health insurance or pay a hefty payroll tax. This would combine Obama's new taxes on capital with a new tax on labor — precisely what we don't need in the middle of a deep recession. Also, candidate Obama envisioned an outside-the-workplace health insurance exchange that would threaten to unravel the employer-based health care system. He also promised a permanent expansion of Medicaid, which will induce people to drop their private coverage in favor of insurance provided at taxpayer expense. [link]
What we have seen so far is not encouraging — either for the economy or the health care system.