Investment income tax practices hurt Medicare

By Cynthia Wilson

Ever wonder how Medicare is funded?

Medicare Part A hospital insurance is funded by payroll taxes.  Americans  automatically receive this coverage when they become 65 years-old. If you receive a paycheck or income from self-employment, you have to pay this tax to support this coverage.

However, investment income withdrawn on holdings held at least a year are taxed at the maximum capital gains rate of 15%. That tax revenue goes into the nation’s general fund.  Those taxes may help fund Medicare but are not specifically earmarked for Medicare.

Many corporate executives and investment fund managers no longer receive most of their income via a payroll check like most Americans.  Instead they  receive stock in the company or the funds they manage. When they sell the stock or receive a dividend payment,  the income is taxed at the capital gains rate.  So taxes on ordinary income that previously would have been collected to fund Medicare are not.

Although investment portfolio managers charge a management fee for the funds they oversee many, if not most, don’t receive the fee as ordinary income.  Instead they opt to channel the untaxed fee back into the fund and take payment in the form of investment income, which is taxed at the lower capital gains rate.

This practice is another important reason that the Medicare trust is underfunded. Millions, if not billions, in payroll taxes that used to help fund Medicare is no longer being collected.  Americans currently pay Social Security taxes on up to $110,100 of their taxable income.  But there is no limit on the amount paid on taxable earnings for Medicare’s Hospital Insurance taxes, which funds Medicare Part A.

Perhaps there should be a limit on the Medicare tax paid annually. However, the current practice of allowing anyone to avoid paying into the Medicare fund by taking their income for work performed through capital gains is not right.

Why should a 16-year old working at the drive-through at your favorite fast food restaurant be required to pay into the Medicare fund while the chain’s top executives and investment analysts are allowed to dodge the tax because they take advantage of tax loopholes that allow them to be compensated with stock and other investment income?

The 16-year old worker and the executives contribute to the success of the company. And the analysts don’t sit passively by awaiting their investment income. They “manage”  the funds. Under this nation’s Medicare rules, they all automatically receive Medicare Part A insurance when and if they reach the age of eligibility, which currently is 65.

If federal lawmakers don’t reach an agreement on the tax code before the Bush Tax Cuts expire, starting in 2013 the maximum federal tax rate on long-term capital gains will be 23.8%, in part because the Affordable Care Act assesses a 3.8% Medicare tax on qualifying capital gains income to get back some of the  funds Medicare lost because of investment tax practices. The maximum tax rate on dividend income will be  43.4%.

The higher dividend tax rate should be enough incentive for Republicans to abandon their no “higher tax under any circumstances” position and work with the Democrats to reach an agreement to put America and Medicare on more stable ground. Even billionaire industrialist David Koch, who supports Mitt Romney, thinks tax increases may be necessary.

It’s time to stop pretending otherwise. If we don’t, then we all lose.