Forbes post, “Does The Medicare Payroll Tax Still Make Sense?”

Originally published at Forbes.com on April 16, 2018.

Happy Tax Day! — or, rather, Tax Day Eve, or the day after Tax Weekend.

For some Forbes readers, it’s a day like any other, if you filed your taxes as early as possible to get your refund, or if your tax advisor is doing all of the heavy lifting.  But others of you are, like me, wading through a thick pile of forms and muttering to yourself, “file your taxes on a postcard – ha!”  And for some of you, two of those forms, Form 8960, for the Net Investment Income Tax, and Form 8959, for the Additional Medicare Tax, have been making your life just a little bit harder since Obamacare/the Affordable Care Act was implemented.  (Yes, given the income thresholds required before those taxes come into play, those unaffected may not feel too much sympathy, or may not even be aware of them, depending readers’ degree of nerdiness about tax and health care topics, but bear with me.)

Let’s review how Medicare is funded:

Parts B (outpatient/doctors’ services) and D (drugs) are funded via a combination of funds from general federal revenues as well as premium payments, not unlike other federal programs.  But Part A, hospital services, that is, the original Medicare program, is funded via payroll/FICA taxes of 1.45% for employer and employee.  Originally the tax was capped in the same manner as Social Security still is, but in 1994, the ceiling was removed.  Also, as part of the Affordable Care Act, in 2013, two additional taxes were instituted.  For households with income over $250,000, an increase of 0.9% was added for that marginal income in the Additional Medicare Tax, for a total tax rate of 3.8%, and, in addition, for those same households, investment income was taxed at 3.8% as well.

These taxes feed into a Trust Fund, similar to the Social Security Trust Fund, and, like the Social Security Trust Fund, it’s projected to be exhausted, in this case in 2029, at which point, Medicare Part A will nominally be able to pay 88% of benefits.  But unlike (or perhaps, just as with) Social Security, there is no real concern that benefit checks will be reduced by 12%, or that Medicare will pay for 88% of its usual benefits coverage.  Instead it is generally presumed that the same sort of adjustments to provider reimbursements, efforts at coordination of care, and effectiveness initiatives that have been ongoing, or, failing that, another tax hike, will continue to defer this Doomsday.

For Social Security, there are reasonable grounds for a payroll tax, since benefits accrue based on wages, not on total income, and accrue to individuals, not to households.  But for Medicare, there is no relationship between the amount of tax one has paid and the benefits one receives upon retirement.  To be sure, as with Social Security, there are eligibility requirements; one must contribute into the system for ten years, or, alternatively, have been married to a spouse who contributed.  But this effectively functions as a residency requirement to exclude comparatively recent immigrants, and, in turn, a more relaxed requirement permits the purchase of Part A benefits with five years of residency in the country.  There’s no reason why a FICA tax, per se, is needed to implement these requirements.

So, to go back to the question I asked in the title of this brief column, why not fund the system through general revenues, and increase tax rates by the equivalent amount to do so?  It would, after all, be a small step toward tax simplification.

There are two potential answers.  One is cynical, the other pragmatic.

Readers may recall the claims that anti-Obamacare townhall protesters demanded, “Hands off my Medicare!,” for which they were mocked by Affordable Care Act supporters who deemed this proof that the government was perfectly well able to run large health care systems.  More recently, Democrats/Progressives have taken their turn with this “hands off” rallying cry, in response to Republicans again raising the issue of entitlement reform.  Consider these words from an opinion column from Robert Reich from this past February,

Americans pay into Social Security and Medicare throughout their entire working lives. It’s Americans’ own money they’re getting back through these programs.

Preserving Medicare funding via FICA taxes maintains the fiction that Medicare benefits are not merely a manifestation of society’s obligation to care for the elderly, but earned in an almost contractual way.  It gets the job done, in terms of galvanizing public support, but it’s deceptive, because a percent-of-pay contribution for medical care inevitably means that higher earners subsidize lower earners.

On the other hand, “if it ain’t broke, don’t fix it.”  As much as the public perception of Medicare may put up roadblocks for modernizing the system, the separate stream of funding may at least have the advantage of forcing attention to Medicare costs instead of leaving it ignored as just one more piece of the deficit.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.