Increase the Payroll Tax Rate for Medicare Hospital Insurance
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||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Change in Revenues|
|Increase rate by 1 percentage point||51.4||80.8||84.2||87.4||90.8||94.2||97.8||100.4||103.6||107.6||394.6||898.3|
|Increase rate by 2 percentage points||102.3||160.7||167.5||173.9||180.5||187.4||194.5||199.6||206.0||214.1||784.9||1,786.5|
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. For employees, 1.45 percent is deducted from their paychecks and 1.45 percent is paid by their employers. Self-employed individuals generally pay 2.9 percent of their net self-employment income in HI taxes. Unlike the payroll tax for Social Security, which applies to earnings up to an annual maximum ($128,400 in 2018), the 2.9 percent HI tax is levied on total earnings.
Workers with higher earnings are also subject to a surtax on all earnings above a certain threshold: $200,000 for unmarried taxpayers and $250,000 for married couples who file jointly. At those thresholds, the portion of the HI tax that employees pay increases by 0.9 percentage points, to a total of 2.35 percent. 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.
Over the past 10 years, outlays for the HI program have grown at a much faster pace than revenues derived from the payroll tax. Since 2008, expenditures for HI have generally exceeded the program's total income—including interest credited to the Hospital Insurance Trust Fund—so the trust fund's balances have declined. The Congressional Budget Office projects that if current law remained in place, the balances would generally continue to fall until the HI trust fund was exhausted in 2026.
In 2017, HI receipts from payroll taxes totaled about $256 billion. In CBO's projections, HI receipts rise through 2028 at a rate slightly faster than gross domestic product (GDP), chiefly because wages and salaries are projected to rise as a share of GDP over the next decade.
This option consists of two alternatives. The first alternative would increase the basic HI tax on total earnings by 1.0 percentage point. The second alternative would increase the basic HI tax on total earnings by 2.0 percentage points. Those rate increases would be evenly split between employers and employees. For example, for the 1.0 percentage-point increase, 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 who file jointly), the HI tax on earnings that exceeded 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.
Effects on the Budget
If implemented, the first alternative would increase revenues by $898 billion from 2019 through 2028, according to estimates by the staff of the Joint Committee on Taxation (JCT). JCT estimates that the second alternative would increase revenues by $1,787 billion over the same period, roughly double the increase of the first alternative. Those estimates incorporate the assumption that total compensation would remain unchanged but allow for behavioral responses to the higher tax. (Total compensation comprises taxable wages and benefits, nontaxable benefits, and employers' contributions to payroll taxes.)
If total compensation remained unchanged, then increases in employers' contributions to payroll taxes would have to reduce other forms of compensation. The decrease in taxable wages and benefits would reduce the income base for individual income and payroll taxes, partially offsetting the increase in employers' payroll taxes. The estimates for the option reflect that income and payroll tax offset.
In addition, the higher payroll tax would create an incentive for employers and employees to change the composition of compensation, shifting from taxable compensation to forms of nontaxable compensation. The estimates account for that behavioral response.
The estimates for this option are uncertain primarily because underlying projections of income subject to HI taxes are uncertain. The estimates rely on CBO's projections of the economy over the next decade, particularly projections of wages, income distribution, and employment. Those projections are inherently uncertain.
The main argument in favor of the option is that receipts from the HI payroll tax are currently not sufficient to cover the costs of the program, and increasing that tax would shrink the gap between the program's costs and the revenues that finance it. Each alternative would extend the exhaustion date for the HI trust fund beyond the 10-year projection period. (However, given the uncertainty in projections of Medicare spending, CBO does not make projections of the HI trust fund beyond the 10-year window and therefore cannot estimate its exhaustion date.) Another argument in support of the option is that an increase in the tax rate would be simpler to administer than most other types of tax increases because it would require relatively minor changes to the current tax system.
A drawback of the option is that it would encourage people to reduce the hours they work. When statutory tax rates increase, people have an incentive to work fewer hours because other uses of their time become relatively more attractive. (Increases in statutory tax rates can also cause people to work more hours, because having less after-tax income requires additional work to maintain the same standard of living. On balance, however, CBO estimates that the former effect would be greater than the latter effect.)
Another disadvantage of the option is that it would increase the tax burden of lower-income workers relative to that of workers with higher income. That is because a larger share of the income of lower-income families is, on average, from earnings, which are subject to the HI tax. As a result, an increase in the HI tax would represent a greater proportion of the income of lower-income taxpayers than would be the case for higher-income taxpayers. Moreover, because the option would not make any changes to the Medicare program, the increase in the tax burden would not be offset by greater Medicare benefits when people reached the age of 65.