Increase the Payroll Tax Rate for Medicare Hospital Insurance by 1 Percentage Point

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of dollars 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2015-2019 2015-2024
Change in Revenues 45 71 74 77 80 84 87 91 95 99 346 800

Source: Staff of the Joint Committee on Taxation.

Note: This option would take effect in January 2015. Estimates are relative to CBO’s April 2014 baseline projections. The estimate includes the reduction in individual income tax revenues that would result from a shift of some labor compensation from a taxable to a nontaxable form.

The primary source of financing for Hospital Insurance (HI) benefits provided under Medicare Part A is the HI payroll tax. The basic HI tax is 2.9 percent of earnings: 1.45 percent is deducted from employees’ paychecks, and 1.45 percent is paid by employers. Self-employed individuals generally pay 2.9 percent of their net income in HI taxes. Unlike the payroll tax for Social Security, which applies to earnings up to an annual maximum ($117,00 in calendar year 2014), the 2.9 percent HI tax is levied on total earnings.

In addition, at earnings above $200,000, the portion of the HI tax that employees pay increases by a 0.9 percentage point surtax—to a total of 2.35 percent. (For a married couple filing an income tax return jointly, the surtax applies to the couple’s combined earnings above $250,000.) The surtax does not apply to the portion of the HI tax paid by employers, which remains 1.45 percent of earnings, regardless of how much the worker earns.

This option would increase the basic HI tax on total earnings by 1.0 percentage point. The basic rate for both employers and employees would increase by 0.5 percentage points, to 1.95 percent, resulting in a combined rate of 3.9 percent. The rate paid by self-employed people would also rise to 3.9 percent. For taxpayers with earnings above $200,000 ($250,000 for married couples filing jointly), the HI tax on earnings in excess of the surtax threshold would increase from 3.8 percent to 4.8 percent; employees would pay 2.85 percent, and employers would pay the remaining 1.95 percent.