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Health Care Reform’s Hidden Tax Gem

The best surprise in the new health care reform legislation: a precedent-setting swipe at executive pay excess.

By Sam Pizzigati

The health care reform package that President Obama signed into law last week will give many millions of Americans better access to health care. We can say that with certainty. Here’s what we cannot say with certainty: The wider access that health care reform now ensures will make America a much healthier nation.

Why can’t we say this? Here’s why: Access to health care does not make people healthy. American middle-income people who already have health care, research has shown [1], have far worse health, as measured by a variety of yardsticks, than comparable middle-income people in Japan and many other nations.

If health care doesn’t automatically translate into healthier societies, the obvious question becomes, then what does? Equality. People who live in more equal societies, epidemiologists have documented [2], live longer and healthier lives than people who live in more unequal societies.

But here’s the encouraging news: The just-passed health care reform package includes provisions that will help make the United States more equal. Some of these provisions are starting to receive considerable press attention. The health care reform package overall, New York Times analyst David Leonhardt noted [3] last week, just may represent “the federal government’s biggest attack on economic inequality since inequality began rising more than three decades ago.”

The legislation’s benefits, Leonhardt would go on to explain, will go mostly to “households making less than four times the poverty level — $88,200 for a family of four people.” The bill for these benefits will go to taxpayers at the top.

Top income shares chart [4]Americans making over $1 million a year will see their tax bill jump on average by nearly $46,000 [4] in 2013, thanks largely to a provision in the legislation that, for the first time ever, will apply Medicare taxes to investment income.

This represents a major shift in tax policy. Up until now, Medicare taxes have been, at worst, a minor irritant for the rich, since the wealthy get most of their income from the money their money makes, not the work they do.

The new health care reform subjects this investment income — dividends, interest, and the capital gains from buying and selling stock and other assets — to a 3.8 percent Medicare tax. This new levy will apply only to the investment income of individuals affluent enough to make over $200,000. For couples, the tax will kick in on incomes over $250,000.

Paycheck income over these same levels will see a Medicare tax rate increase from 1.45 to 2.35 percent. This slight increase alone, for a Wall Streeter making $5 million in salary and bonus, will mean a $43,200 tax hike, calculates [5] the consulting firm Deloitte Tax LLP.

But the new health care reform legislation makes tax-the-rich progress on another front as well, progress that has so far gone almost totally unreported. The reform package denies [6] health insurance companies corporate tax deductions on any executive pay that runs over $500,000 a year.

Under current law, the more insurance companies — or any other companies — pay their top executives, the more they can deduct off their taxes as a “business expense” and the less they pay in taxes. That reality leaves average Americans, in effect, subsidizing excessive executive pay.

In 1993, amid an earlier epoch of public outrage over CEO pay, Congress passed a tax code change that limits corporate tax deductions for executive compensation to $1 million per exec. But that “reform” came with an enormous loophole. The limit didn’t apply to any executive “pay for performance.” Corporations, since 1993, have simply paid their top executives $1 million or so in regular pay and defined everything else they stuff into executive pockets as “performance-based” compensation. Health insurance corporations, for their part, have done an incredible amount of stuffing.

signup [7]In 2007 and 2008, CEOs at the nation’s top five health insurance companies together took home [8] over $113 million. In 2008 alone, the Corporate Library reported [9] last August, 38 health insurer execs made over $5 million. This past December, Cigna CEO H. Edward Hanway retired [10] with a $73 million bonus. 

Two years ago, early in the bank bailout, Congress finally took a move against the executive pay deductibility loophole. The original bank bailout legislation limited deductions for executive pay to $500,000 and defined executive pay to cover all compensation, even the previously exempt “pay for performance.” But this bank bailout executive pay deductibility limit only applied to banks taking in major bailout dollars under the TARP program. Banks, once they paid back their TARP money, could resume deducting to their heart’s content.

The health care reform legislation has now taken this temporary limit on how much executive pay bailed-out banks can deduct off their taxes and made it permanent — for all health care insurers.

A big deal? Potentially, yes. The new health care reform, we need to keep in mind, is going to be delivering millions of new customers to health insurance companies. These deliveries could easily translate into new personal windfalls for top insurance executives, since nothing in the reform legislation explicitly caps how much insurers can shell out in executive compensation.

But the legislation’s new limit on how much executive pay insurers can deduct off their taxes will penalize any insurer that compensates execs at over $500,000.

The big health insurers, to be sure, will likely simply pay this penalty and continue to overcompensate their power suits. And this reality brings us to the point that progressive supporters of the new health care reform legislation have been making over and over: This legislation represents only a first step.

The legislation, these progressives are pointing out, establishes a vital health care principle — that government has an obligation to ensure all Americans access to quality, affordable health care — but doesn’t do nearly enough to make that principle universally operational.

By the same token, the new health care legislation establishes a vitally important principle on executive pay: that our tax dollars should not in any way subsidize executive excess. But the $500,000 deductibility limit in the legislation won’t, by itself, ensure that our tax dollars aren’t doing this subsidizing.

Still, the deductibility limit does point us in the right direction. Lawmakers can build upon it, just as they can and should build on other inadequacies in the legislation. If lawmakers, after all, can deny health insurance companies tax deductions on excessive executive pay, they can also take tougher steps.

Lawmakers, for instance, could deny health insurers that pay execs excessively access to customers in the new health insurance marketplace — the “exchanges” — that the reform law establishes.

And if lawmakers can take steps to discourage executive excess at health insurance companies that get our tax dollars, they can also take steps to discourage executive excess at all companies that take in our tax dollars. They could, for example, deny government contracts to firms that pay their executives over 25 or 50 times what their workers are making.

If lawmakers took steps like these, the United States would begin to become a substantially more equal nation. And a healthier one, too.

Sam Pizzigati edits Too Much, the online newsletter on excess and inequality published by the Washington, D.C.-based Institute for Policy Studies. Too Much appears weekly. Read the current issue [11] or sign up [7] to receive Too Much in your email inbox.