President Biden has proposed several tax increases on households making more than $400,000 per year in order to extend the solvency of the Medicare program. The Congressional Budget Office (CBO) projected in February that the Medicare Hospital Insurance (HI) Trust Fund would be insolvent in 2033, while the Medicare trustees last projected in June 2022 that the HI Trust Fund would be insolvent in 2028. The Biden administration claims their tax proposals, along with further reductions to the prices Medicare pays for prescription drugs, would extend the solvency of the HI Trust Fund into the 2050s.
Here’s what you need to know about President Biden’s proposals.
While the Biden administration frames its tax proposals as having two parts, we find it more helpful to frame them as four distinct proposals:
- An increase in the payroll tax rate on earned income (i.e., wages and net self-employment income) above $400,000 from 3.8 percent to 5.0 percent; this would presumably be accomplished by increasing the 0.9 percent Additional Medicare Tax rate, which currently applies to income above $200,000 for single filers and $250,000 for married couples filing jointly, to 2.1 percent for households making above $400,000 per year. Unlike the first 2.9 percent in Medicare payroll taxes, which is split evenly between a worker and their employer for those with wage income (i.e., 1.45 percentage points each), the 2.1 percent in Additional Medicare Tax for income above $400,000 would be borne entirely by the worker.
- An increase in the net investment income tax (NIIT) on unearned income (i.e., “interest, dividends, annuities, royalties, certain rents, and certain other passive business income”) for households making above $400,000 per year, from 3.8 percent to 5.0 percent of NIIT.
- An expansion in the Medicare payroll tax base and the NIIT base to pass-through business income (i.e., income received from partners or owners who are “actively involved in running” a pass-through business) for households making above $400,000 per year; and
- A dedication of NIIT revenue to the Medicare HI Trust Fund for the first time, shoring up the trust fund by shifting revenues from Treasury’s General Fund at the same time.
Until President Biden releases further budget details, it is unclear how much additional revenue the first two proposals would raise. The third proposal, expanding the Medicare payroll tax and NIIT bases to pass-through business income, could raise around $250 billion in tax revenues over the next decade if the President’s proposal mirrors a similar proposal scored by CBO in its December 2022 options to reduce the deficit. That entire $250 billion in additional revenue would go to the HI Trust Fund under the fourth proposal, as would more than $150 billion in current projected NIIT revenue from FYs 2024 through 2026 per the Joint Committee on Taxation (JCT did not project NIIT revenue beyond FY 2026 in its latest report).
Who might these tax changes affect most?
President Biden has pledged to not raise taxes on households making less than $400,000. There’s been considerable confusion over this pledge, including whether it applies to single filers, married couples filing jointly, or both. (Applying the $400,000 threshold only to married couples filing jointly would protect more taxpayers from tax increases under the Biden pledge, if the corresponding threshold for single filers was set to $200,000.)
The Internal Revenue Service (IRS) does not specifically break down how many taxpayers reported income of $400,000 or more in its annual statistics of income (SOI) data, but it did report that in tax year 2020 1.1 percent of tax returns (1.84 million) reported income of greater than $500,000 and 5.8 percent of tax returns (9.46 million) reported income of greater than $200,000. For the current filing season (for tax year 2022), the number of returns with income above these thresholds will almost certainly be greater due to high inflation in recent years.
For now, though, President Biden’s tax changes would affect a small percentage of American households – likely between one and three percent.
That percentage would grow, however, if the Biden tax proposals are not indexed to inflation.
When the 0.9 percent Additional Medicare Tax and the 3.8 percent NIIT were created, both as part of the Affordable Care Act (ACA) in 2010 and made effective starting in 2013, they applied to income for single filers making above $200,000 and married couples filing jointly making above $250,000. Neither of those income thresholds were indexed to inflation, meaning that as taxpayers’ incomes rise with inflation more and more taxpayers are paying the Additional Medicare Tax and the NIIT. In the first year of the NIIT (2013), 3.1 million households paid the tax; in 2020, 5.7 million households paid the tax (an 84 percent increase over seven years). This is a phenomenon known as “bracket creep.”
NTU President Pete Sepp warned about this inflation-indexing issue with the Additional Medicare Tax and the NIIT in an extensive 2010 issue brief.
If the Additional Medicare Tax and NIIT thresholds had been indexed to inflation from the time they became effective, they would be around $260,000 for single filers and $325,000 for joint filers today. Because the thresholds were not indexed to inflation, a single filer making around $155,000 at the time the Additional Medicare Tax and NIIT became effective in 2013 – and whose wages have increased with inflation since – is paying these taxes starting this year, the same for a couple filing jointly and making around $195,000 in 2013 whose wages have increased with inflation.
Sepp also pointed out at the time that the Additional Medicare Tax and the NIIT came with a significant marriage penalty, given the threshold at which the taxes applied to married couples filing jointly was not double the threshold for single filers but instead just 1.25 times the single filer threshold.
What this effectively means is that two single taxpayers making $150,000 each who get married and decide to file jointly will pay more in taxes ($450 just in Additional Medicare Tax) than they would if they remained single (they would pay $0 as single taxpayers, since the Additional Medicare Tax doesn’t apply to single taxpayers until they reach $200,000 in income). It is unclear how President Biden’s new proposals would address marriage penalties; as noted above this has long been a point of confusion with his $400,000 pledge.
How might these tax changes affect investment?
It’s difficult to determine how significantly President Biden’s proposals would affect investment in the U.S., but by increasing the tax rate on investment (particularly the increased NIIT rate from 3.8 percent to 5.0 percent for households with more than $400,000 in income) the Biden proposals may negatively impact investment. The expansion of the Additional Medicare Tax and NIIT bases to pass-through business income may also discourage investment by affecting how business owners and partners organize both their business structure and the income they receive from their business activity.
How might these tax changes affect tax administration?
President Biden’s proposal would likely increase tax administrative burdens for the IRS and increase tax compliance costs for individuals and businesses. Expanding the Additional Medicare Tax and NIIT bases to include pass-through business income could result in tens or even hundreds of thousands of additional taxpayers reporting Additional Medicare Tax and/or NIIT liabilities. This could enhance the complexity of these returns reported to the IRS, resulting in higher administrative burdens at the IRS for processing these returns.
While the additional 2.1 percent tax on earned income above $400,000 would be borne by workers and not employers, “employers are required to withhold the Additional Medicare Tax when it applies given their knowledge of the employee’s situation (reported filing status and wages paid by that employer).” However, it is unclear how much additional compliance costs employers will face given that for workers with earned income above $400,000 employers are already withholding an additional 0.9 percent tax.
Pass-through business owners will not only face additional tax burdens but additional tax compliance burdens, since the Biden proposals expand the Medicare payroll tax and NIIT bases to pass-through business income for taxpayers making above $400,000. The Biden pledge may create perverse incentives here, since presumably the pledge would require a pass-through business owner with $395,000 in income to not be subject to the 2.1 percentage points in Additional Medicare Tax and 1.2 percentage points in additional NIIT while a pass-through business owner with just $5,000 more in income would be subject to both taxes.
How might these changes affect the federal budget?
The Biden proposals would raise revenue and reduce federal deficits relative to current law, though on net they may result in less revenue flowing into the Treasury’s General Fund. While all new revenues under the Biden proposals would be applied to the HI Trust Fund, the Biden administration would also shift existing NIIT revenues to the HI Trust Fund. Currently, NIIT revenues go to Treasury’s General Fund.
As former Obama administration official Jason Furman has pointed out, the architects of the ACA intended for NIIT revenues to go to the HI Trust Fund but that provision was removed from the bill due to Byrd rule reconciliation limits. JCT projects that in the most recent fiscal year (2022), the current fiscal year (2023), and the next three fiscal years (2024-2026), NIIT revenues will average around $50 billion per year.