US Fiscal Cliff Fair Trade-Off #1: Tax Employer-Provided Health Insurance in Exchange For a Lower Business Income Tax Rate

When I ponder ways to solve the US Fiscal Cliff, there are two items which clearly make little sense to me, from a fairness perspective.

I can’t see the logic of the Obama Administration’s proposal in their Business Income Tax Reform of reducing the top corporate income tax rate from 35% to 28%, and then, at the same time, also wanting to increase the individual income tax rate up to 39.6% on the higher amounts of net business income of individuals and of business income passed through to individuals by SubS Corps, by LLCs, and by Partnerships.

Now granted there are some entities that are formed mainly to just avoid C Corp income tax, such as many REITs and many Master Limited Partnerships.  The best way to fairly deal with that is to simply make these entities pay income tax just as a C Corp does. 

And also granted, there needs to be a clear demarcation as to what is truly owner compensation and what is net business income, but the true net business income portion is no different from C Corp Taxable Income, and thus I think there shouldn’t be such a huge difference in the top income tax rates applied to it (39.6%) as that which is applied to C Corp Taxable Income (28%).

Frankly, I think a reduction in the top corporate income tax rate from 35% to 28% is too extreme.  I would instead make the tax rates dramatically more progressive, since the lower amounts of business income is where the maximum amount of US job creation is derived, and perhaps reduce the top corporate income tax rate on the highest amount of C Corporate Income to something like 30%.  But still, that is 10% higher than the roughly 40% tax rate on the highest amount of taxable income if we go with the Clinton individual income tax rates.

So, I think John Boehner has a good point when he says that the top tax rate on net business income of 39.6% is too high.  But I do think his definition of business income is incorrect……a lot of it is truly compensation of owners, much of which clearly should be taxed at the higher 39.6% tax rate.  But true net business income passed through shouldn’t be taxed at 39.6%.  It should clearly be higher than the present 35.0% top income tax rate, but perhaps splitting the difference between the 39.6% and the 35.0% tax rates would be the fair way to go, which would yield a top income tax rate for net business income of 37.3% at the individual tax level.    

So how do you offset the lower than 39.6% top tax rate on some of this net business income?

Well, the most egregious tax loophole on the individual side is employer-provided tax-free health insurance benefits to its employees.

Why is it the most egregious?

Well, there clearly is nothing wrong with a business paying for health insurance for its employees.  It is a very key ingredient of an employee's total compensation package.

Presently, if these employees didn't have this company provided health insurance, they could either obtain health insurance on their own and also pay for it on their own, or they could elect to not have any insurance at all.

But what in the world gives the US Government the right to effectively turn this key element of a total compensation package into something akin to tax-free municipal interest?

What this US Government tax policy does is significantly expand further the economic gap between the rich and the poor, and more specifically in this case, the huge economic gap between the employed and the unemployed, and also the huge economic gap between the employed and the underemployed.

So this US Government tax policy is a clear tax loophole, which singles out a clearly compensation component of a total compensation package as something that should be free of income tax, forever.

In this US Fiscal Cliff Debate, I think in deciding what to tax, what not to tax, what US Government expenditures to cut and what not to cut, the driving force behind these decisions should be what choices result in the maximum amount of sustainable US full-time job creation, at a livable wage, and as quickly as possible.

What this tax-free health insurance compensation does is to reward people who already have a job.  You can't get it unless you are employed.  Thus, by eliminating this tax loophole, you lose no US jobs.  But yet you provide a substantial amount of money for the US Government to fund true US full-time job creation, at a livable wage.

And the unemployed are totally removed from the opportunity to take advantage of this tax loophole.  There is no way they can get this tax-free health insurance provided by the US Government because they don't have a job, and thus don't have an employer providing this benefit for them.

And the same goes for the many underemployed, whose employer will not provide them with health insurance, thus they can't take advantage of this US Government provided tax loophole for just those fortunate to be employed full-time.

But it's more than expanding the economic gap between the employed and both the unemployed and the underemployed.

This US Government tax loophole also further expands the economic gap between the very wealthy employed and all the rest of the employed.

Why?  Well, there's a couple of things at play here.

First, the very wealthy employed receive substantially more in company provided health insurance benefits than do everyone else employed by the company.  Thus, they not only get more of this employer-provided health insurance compensation, but they also receive more of a US Government tax loophole from having a higher amount of this tax-free health insurance excluded from their taxable income.

And second, the very wealthy employed get an additional US Government tax loophole amount of tax benefit here because they have a higher top marginal income tax rate.  Thus, they not only get a larger amount of tax-free income, but their after-tax benefit impact is even more substantial because they now are able to avoid this tax-free income, which would otherwise be taxed at 35% presently, or at 39.6% starting in 2013 under President Obama's tax proposal.

On the other hand, the tax benefit rate for so many of the non-wealthy employees will not be at a 39.6% tax rate, but rather at a tax benefit rate that is substantially lower, with the overwhelming majority of it at a tax benefit rate of 15% or lower, although some would have a tax benefit rate of 25%.

So, let me do the math to shed additional light on this.

Let's say you have an executive, whose total compensation is significantly above $250,000, and who also receives a very lucrative $20,000 of employer-provided health insurance.

Thus, in 2013, this executive would be receiving an after-tax loophole from the US Government of $7,920, or 39.6% X $20,000.

Then let's say you have an accountant, working for the same company, whose total compensation is say $50,000, and who also receives a fair-to-middling $10,000 of employer-provided health insurance.

Thus, in 2013, this hard-working green eyeshader would be receiving an after-tax loophole from the US Government of only $1,500, or 15% X $10,000.

Thus, in the above example, the highly paid executive receives a tax largesse from the US Government of $7,920, which is a massive 5.3 times the $1,500 tax largesse received by the accountant.

Where's the fairness here?

And people don't understand why there continues to be such a huge gap between the wealthy and everyone else?

And the US Congress, from both sides of the aisle, continues to enact patently unfair tax policies like this one, and then piles on by attempting to hide from their constituencies their votes on, or not allow there to be a vote on this at all, which continues to further expand the huge economic gap between the wealthy and everyone else?

Because there is such a huge difference between what the tax largesse the wealthy executive receives here and what the just regular employee receives, the focus of sound, fair governance should be to address the most egregious element here, and that clearly is the substantially higher tax largesse received by someone having a very high Adjusted Gross Income.
  

Thus, that's why I think it is imperative that this tax-free health insurance of those making over $250,000 be taxable, as a key component of this US Fiscal Cliff deliberations.  And yeah, that means that there will be quite a few more US taxpayers who will now have some of their income taxed at a higher tax rate just because this present tax-free health insurance compensatory income, which is now not included in their Adjusted Gross Income, will fairly increase their Adjusted Gross Income, starting in 2013.

When you consider that the above example resulted in $7,920 of higher US federal income taxes in just one year for just one highly-paid executive, the total amount of US Government Revenues that could be raised here has to be just huge.

But to be totally fair, I would scale in the elimination of this egregious tax loophole, and thus the amount of this tax loophole elimination would increase as Adjusted Gross Income above $250,000 increases, but for sure, anyone with Adjusted Gross Income above $1 million should have his/her entire health insurance compensation be taxable starting in 2013.

And going back to the driving test between choices in solving the US Fiscal Cliff, the elimination of this tax loophole for just those making more than $250,000 will result in absolutely no US full-time jobs lost.

But then using the substantial tax revenues raised here to lower income tax rates on lower amounts of true US Business Income taxed at the individual level, coupled with not raising the top income tax rate on US Business Income much above 35.0%, would clearly be very stimulative to the US economy and to US full-time job creation, at a livable wage, and right away.

I think this is a wisely-crafted, fair trade off to help solve the US Fiscal Cliff, which is causing such havoc on the US economy.

Furthermore, I think it would be unconscionable for the US Congress to pass a reduction of Medicare Benefits in order to either solve the US Fiscal Cliff and/or the US Debt Grand Bargain, and at the same time, to permit very wealthy individuals to continue to exclude from their US federal taxable income the huge amounts of employer-provided health insurance compensation they receive each year.

If this were to happen, I think you would have an incensed retirement and near retirement communities.

Also if this were to happen, I think that retirees could logically conclude that their reduced Medicare Benefits are in essence paying for the large tax loopholes received by the younger very wealthy Americans from their tax-free employer-provided health insurance compensation.....in essence, a massive transfer of after-tax health care wealth from older Americans to the very wealthier, much healthier, younger Americans.