"A Payroll Tax on UInearned Income - A Slippery Slope"

Sydney M. Williams

Thought of the Day

“A Payroll Tax on Unearned Income – A Slippery Slope”

March 18, 2010

Why, when the economy and capital markets continue in need of resuscitation, would the White House decide a Medicare tax (A payroll tax) should be imposed on unearned income?

Currently the Medicare tax is 2.9%, half paid by the employer and half by the employee. The President’s proposal is two-fold: first, Medicare taxes on individuals whose income exceeds $200,000 ($250,000 for couples) would increase from 1.45% to 2.35%. The employer’s share would remain at 1.45%. Introducing an element of progression into the system is understandable and could well be considered fair. But the second part of the proposal would apply a 2.9% tax on unearned income – dividends, capital gains, royalties, annuities and rents.

That proposal, therefore, introduces a fundamental change to the system. In effect, it changes Medicare taxes from a payroll tax to an income tax – opening the door to possibly making similar changes to Social Security – a radical departure, and made more onerous as the Bush tax cuts are scheduled to end at the close of 2010. Long term capital gains will revert from 15% to 20% and the tax on dividends will rise from 15% to 39.5%. The addition of a payroll tax on top of the increases coming anyway would make those taxes, at the top end, 22.9% and 42.4% respectively.

The Country has significant funding problems, as we look out over the next two or three decades. Entitlement programs, such as Medicare, Medicaid and Social Security are seriously under funded. Adding another entitlement program – government mandated health care reform – only aggravates the situation. Consumers, for years, have spent more than they earned. Savings are at very low levels and the state of 401K and related plans are seriously low in terms of capital. What is needed is encouragement for consumers to save more and to consume less. Increasing taxes on invested capital only makes the situation worse.

The President made a big thing of hiring behavioral economists when he entered the White House, men like Cass Sunstein, co-author with, Richard Thaler, of Nudge, Jeffrey Liebman from Harvard and Austan Goolsbee from the University of Chicago. He should be using them to “nudge” the economy in a direction that encourages individual investment and discourages unnecessary consumption.

Imposing payroll taxes on unearned income sends the opposite message.