The voices of Tax Policy Center's researchers and staff
The chaos surrounding Senate efforts to replace the Affordable Care Act will prolong the debate over what Republicans will do about the nearly $1 trillion in taxes the ACA will generate over the next 10 years. It is often said that the GOP wants to scrap those levies because it would make it easier for them to pass a future tax bill. But why?
To understand what’s happening, look at just one of those ACA taxes, the Net Investment Income Tax (or, sadly, the NIIT). It is a 3.8 percent tax surcharge on long-term capital gains, interest, qualified dividends, and other non-wage income for individuals making $200,000 or more and couples making at least $250,000. Thus, high income households pay a 23.8 percent rate on such income (the top rate of 20 percent plus the extra 3.8 percent). Interest and certain other non-wage income is taxed at a top rate of 39.6 percent, plus the NIIT.
Now, think about what Republicans have in mind with the big tax bill they promise to unveil in the fall. One likely item: a big tax cut on investment income, a perennial GOP goal.
What might that look like? In June 2016, the House Republican leadership’s tax blueprint included three ideas relevant to our story. First, it would repeal all the ACA taxes. Next, it would collapse today’s seven individual income tax rates to just three—12-25-33 percent. Then, it would change the way the US currently taxes investment income. Instead of preferential rates, it would tax realized capital gains, interest, and dividends at ordinary tax rates. But, crucially, only half of investment income would be taxable.
Thus, in effect, high income households would pay a maximum rate on such income of 16.5 percent (33 percent on half the applicable income). Those in the 25 percent bracket would pay an effective rate of 12.5 percent and those in the 12 percent bracket would pay 6 percent on their investment income, such as it is.
That’s where the NIIT comes in. By dumping that tax first, they could get the rate down to 20 percent before even they even start on a tax bill.
Here’s the math:
Repealing the NIIT in a health bill gets the top rate on gains and dividends down to 20 percent at a cost of about $150 billion over 10 years. Then, in a tax bill, they could knock the rate down from 20 percent to 16.5 percent. That would cost another $500 billion.
If they can't repeal the NIIT in a health bill, cutting the rate on investment income from 23.8 percent to 16.5 percent with one swing would cost about $630 billion.
Note that taking the rate down to 16.5 percent costs roughly the same whether Congress does it in one step or two. But this is Washington, where the real price of something is almost always less important than the perceived cost. And cutting the tax rate in a health bill would lower the revenue baseline, making it possible for backers of a deep rate cut to claim it is less expensive than it really is.
Of course, Congress could take many other paths. If they can’t nix the NIIT, Hill Republicans could always settle on a tax rate on investment income that is higher than 16.5 percent, though that result would be less satisfying to many of them. Or they could scale back other tax cuts, find offsetting tax increases, or just add more to the national debt. But killing the NIIT and other ACA taxes now would make life much easier for future tax cutters—at least politically.
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