With the U.S. Supreme Court decision that the Affordable Care Act (ACA) is constitutional (except for certain Medicaid expansion provisions), the United States is headed toward one of the largest tax increases in its history. At the end of this calendar year, the existing tax rates and numerous other income tax provisions that have the effect of lowering income tax liabilities expire. The tax provisions that the press prefers to call the “Bush tax cuts” will sunset and income tax rates (as well as phase-out provisions for itemized deductions and personal exemptions and numerous other provisions) will revert to pre-2001 levels. In addition, the individual income tax provisions contained in the ACA take effect. There are three primary taxes placed directly on individuals contained in the ACA.
First, since the individual mandate was determined to be a valid exercise of Congress’s power to tax, the shared responsibility penalty will be imposed on most individuals that fail to carry and maintain minimum essential coverage. This penalty is equal to the lesser of the monthly penalty amounts for months in which minimum essential coverage is not maintained or the national average premium for bronze level qualified health plans which is to be offered through state run insurance exchanges. When completely phased in, the penalty generally should not exceed 2.5% of the excess of a family unit’s adjusted gross income over the income used to determine the need to file an income tax return. There are exemptions for religious reasons, people who cannot afford coverage, and incarcerated individuals.
Next, beginning January 1, 2013, an additional 0.9% Hospital Insurance (HI) tax will be imposed on certain taxpayers. HI is currently imposed on all wages at a 2.90% rate divided equally between the employer and the employee. Starting next year, the additional HI tax will be imposed on wages received with respect to employment on taxpayers in excess of a threshold amount. The threshold amount is $250,000 for individuals filing joint returns; $125,000 for married individuals filing separately; and $200,000 for all other individuals. The HI increase does not affect the tax imposed on the employer, only the employee.
Additionally, beginning January 1, 2013, a tax is imposed on unearned income. The tax is 3.8% of the lesser of income from dividends, interest annuities, rents, royalties and capital gains; or the amount by which modified adjusted gross income exceeds a threshold amount. Modified adjusted gross income is adjusted gross income plus excluded foreign earned income. The threshold amounts are the same as in the preceding paragraph.
When the new taxes are combined with the sunset of the Bush tax cuts, most individuals paying income taxes will see an increase and many individuals will see a dramatic increase. For example, the federal tax rate on taxable dividends will increase from 15% to 43.4%. The people primarily affected by these changes will not be the wealthy since they will simply adjust their spending patterns as needed. As we have seen before, when luxury items are taxed excessively, the people who suffer the most are the producers of those items, not the consumers. In this case, the taxpayers adversely affected will be the high earners who have not accumulated significant wealth. A couple earning $250,000 or so with a mortgage, a car payment or two, and children either in or on the way to college may not be able to adjust quickly or easily to these tax rate changes.
The other adverse effect will be on the U.S. economy as both the wealthy and the high earners have to stop spending more quickly than is good for anyone. The wealthy will postpone purchasing the new yacht; taking the second vacation; or buying the second (or third) house. What will the high earners postpone?