Reconciliation Could Improve Medicare Solvency

According to press reports, policymakers are considering broadening the base of the 3.8 percent Net Investment Income Tax (NIIT) or self-employment payroll taxes as part of a reconciliation bill in order to improve Medicare solvency. The policy under consideration would apparently raise over $200 billion through 2031, which would be enough to extend the Medicare Hospital Insurance (HI) trust fund's solvency by three to four years and close a substantial share of the trust fund's deficit.

Currently, high-income households pay a 3.8 percent Medicare payroll tax on their wage income and a 3.8 percent NIIT on their investment income. However, certain pass-through business income is not subject to either tax. The policy in question would expand the NIIT and/or the Medicare Self-Employed Contributions Act (SECA) tax to cover this pass-through income for individuals making over $400,000 per year and couples making over $500,000 per year. Like the SECA but unlike the current NIIT, revenue for this expansion would be dedicated to the Medicare HI trust fund.1

President Biden proposed a very similar policy in his budget last year. At the time, we criticized the President's version because it diverted existing general revenue to Medicare and double-counted new revenue for both solvency and to finance new spending. By contrast, the reconciliation bill would apparently improve solvency as part of a package to reduce overall deficits and would not rely on these types of budget gimmicks.2

According to press reports, the policy currently under consideration would raise $203 billion through 2031, which would reduce the 2022-2031 Medicare HI cash deficit by over 80 percent based on Congressional Budget Office (CBO) projections and 45 percent according to the Medicare Trustees.

The proposal would also delay insolvency of the trust fund from 2028 to 2031 under the Trustees' baseline and from 2030 to 2034 under CBO's baseline.

Closing the NIIT/SECA loophole would significantly improve Medicare's finances at a time when the HI trust fund is expected to be insolvent within ten years. This is a serious policy worth including in a deficit-reducing reconciliation package. Lawmakers should also consider other Medicare reforms to lower health care costs and improve long-term HI solvency.

1 It is unclear precisely how new revenue will be dedicated to the HI trust fund, and lawmakers may have to work with the Senate parliamentarian to ensure the policy does not run afoul of the Byrd rule’s prohibitions against non-budgetary policies. Currently, traditional payroll taxes and SECA taxes on wages and self-employment income go to the trust fund, while the NIIT does not. Some options available include expanding the NIIT and designating only the expanded part to the trust fund, expanding the SECA tax rather than the NIIT to cover untaxed income, or creating a new tax to cover the untaxed income and dedicating the revenue to the trust fund.

2 The unified federal budget deficit is the sum of all trust fund deficits and surpluses and general government deficits, so improvements in trust fund balances reduce overall budget deficits. Using trust fund revenue to finance spending or tax cuts outside of the trust fund (without a transfer) would amount to double-counting, since the same dollar cannot both fund a dollar of new obligations and a dollar of existing ones. However, improvements to solvency are essentially a form of deficit reduction, and do not represent double-counting unless policymakers are claiming $200 billion of trust fund improvement on top of $500 billion of deficit reduction.