You may have been wondering how the US government planned to pay for all those new users of government mandated medical ‘protection’ – well, here’s the bad news:  There will be a 3.8% tax on net investment income beginning in 2013.

Today successful retirees will need to completely rethink their budgets and allocations of income sources if possible.   Previously, all you needed to consider were the marginal income tax rates to determine what you could net from an investment.  Now, deduct another 4% from what will be available.

The just enacted “Reconciliation” of the two versions of the US Congress massive health care revisions has a substantial Medicare tax levied on income that has never before been included in the social security/Medicare tax scheme.  Until this new law was imposed, most workers earning a salary paid social security taxes up to a maximum salary of $106,800 for 2009 and 2010.  Self-employed entrepreneurs paid both ‘halves’ of the 15.3%.  Employees had half deducted from their salary and their employer paid the other half.  After the government realized that the now-beloved Medicare program could not sustain itself on just the 2.9% portion on earned income, a Medicare Tax adjustment was added in 1993.  Congress removed the upper limits on earned income and that 2.9% tax continues on all earned wages.

President Obama has signed into law a controversial Health Care bill with a comforting title of “Patient Protection Act” with many costly changes being phased in over the next four years.  Some benefits will start immediately – an obvious political decision to hand out the goodies and then wait a year or two before they start to take it all back and then some:

• The new tax law will levy that 3.8% tax on net investment income if your Adjusted Gross Income is above $200,000.  Another example, perhaps, of the ‘sharing the wealth’ concept of the current political agenda? 

Some historical perspective is important to note here.  Social Security started out as a $60 a year tax on workers’ wages intended to provide retirement benefits to individuals over the age of 65.  A related fact to note:  the life expectancy of a white male child born in the middle 1930s was 62!  That $60 a year tax had grown to $468 by 1970 and to $1,605 by 1980.  A top wage earner in 2010 will pay $6,622 social security (their employer will pay the same amount for a total of $13,243) on the first $106,800 he or she earns plus another 1.45% on everything they earn for Medicare.   Self employed individuals will pay the full 15.3% on the first $106,800 for a total tax of $16,340 plus 2.9% on any earnings over $106,800 for Medicare.

• To be fair and balanced, we ought to look at the ‘inflation adjusted costs’.  According to the US Bureau of Labor Statistics, which publishes the inflation data tables, the inflation rate between August, 1937 when Social Security was signed into law, and February 2010 was a whopping 1,394.77% - so that $60 levied against your grandparents would be $896 in 2010 inflation adjusted  terms.  But, the actual social security tax on the maximum earnings in 2010 is over $13,000 plus another $3,000 for Medicare.

As written the “Obama Care” package will soon add an additional 3.8% tax on almost ALL other sources of income.  For now at least, it does exempt qualified retirement plans from the tax base, so your IRA is safe for now.  But if you look at the history cited below, you may not be so confident that it will remain safe. 

Do you really believe that this nearly 4% tax will a) actually cover the costs and b) remain the same low rate?   Is there any prior government ‘benefit’ that has not grossly exceeded the budget in spite of generating huge surpluses?  How about social security or Medicare?  Have they been well-managed and free of waste and fraud?  Will this program be any different?

For those of you whose eyes don’t glaze over looking at numbers and your brain doesn’t shut down reading financial details, the following may be of interest to you.  It will impact you regardless of whether you like to read about it or not.

A bit of comparative history of the growth in Social Security is relevant here.

• On 14 Aug 37 FDR signed into law the original social security program and the administrative organization that grew from that Federal Insurance Contributions Act (thus the name FICA tax) was established.  Ignore the fact that they were not ‘contributions’ as they were not voluntary and they provided no insurance.   The base tax was 2% of the first $3000 earned.  The first retiree according to the history by the SSA received a lump sum distribution of $ 0.17 – that is not a typo:  seventeen cents!  In 1937 a total of $1,278,000 was paid in benefits to 53,236 recipients.   In 1939 coverage was expanded to include survivors and dependents. The base and rate were not changed. 
• In 1950 the tax base expanded to additional income, raised the base to $3,600 and the rate to 3%.  In 1950 $961 million dollars was paid out to 3.3 million beneficiaries.
• In 1956 disability insurance protection was added, an early retirement privilege at 62 for women was permitted and the base was increased to $4200 and the tax rate was raised to 4%.  In 1961 early retirement for men was permitted and payroll taxes increased to 6%.
• On 30 July 1965 President Johnson signed into law Medicare and its companion Medicade as part of his “Great Society” initiative.  Former President Harry Truman was the first enrollee – he began advocating national health care in 1945 and the signing ceremony was held at his presidential library in Independence MO. The Medicare Part B premium was $3 a month.
• In 1966 the combined Social Security and Medicare tax was 4.2% on $6,600, including the new 0.35% Medicare tax, paid by both the employee and employer for a total tax of 8.4%.  Self employed persons paid a 6.4% tax.
• In 1970 $31.9 Billion dollars was paid out to 26.2 million social security beneficiaries.  In 1972 COLAs were added to account for then-rampant inflation effects on retirement benefits. The FICA tax rate increased to 9.2% and the base upped to $9,000. During the 1970s the wage base increased incrementally to $22,900.
• In 1980 $120.6 Billion dollars in benefits were paid out by SSA to 35.6 million beneficiaries.  In 1983 US government civilian employees were added to the Social Security program, and began ‘contributing’ the combined social security and Medicare taxes too.
• In 1990 SSA paid out $247.8 Billion dollars to 39.8 million beneficiaries.  The tax base for SS in 1990 was $51,300 and the FICA tax was 12.4% and the Medicare tax was 2.9% a total of 15.3%.  Since 1993 there has been no upper limit to the Medicare tax levied on salaries and wages.
• In 2000 SSA paid out $407.6 Billion dollars to 45.4 million beneficiaries. In addition SSI, the survivors and dependents benefits, in 2000 totaled $30.7 Billion paid out to 6.6 million beneficiaries. The maximum wage base for SS was $76,200, and the Medicare Part B premium was $45.40 a month. 
• On 8 Dec 2003 President GW Bush signed into law the Medicare Modernization Act, which included the outpatient prescription drug benefit.  The wage base in 2003 was $87,000.
• The wage base in 2010 is $106,800.  The Medicare part B premium is $96.40 unless your 2008 income was over $85k, and if so then you will be assessed a 15% increase in premium to $110.50.  Add to that starting in 2013, the income tax deduction if you itemize, unreimbursed medical expenses will be deductible only to the extent they exceed 10% of your AGI, up from 7.5.

So… if you have read through all that, do you still think the 3.8% tax on net investment income over $200k will still be the law in a few years?  Call me an ole skeptical CPA if you want, but I don’t believe it will for more than the first year.  Remember, they still have two years or so to change their minds about the rate and the base before it actually starts to be collected.  I suspect too, that the IRS will implement some administrative rules to require withholding from dividend and interest payments just to make sure everyone pays their fair share.  Note too, that most of these increases don’t start until after the 2012 Presidential elections.  Hmmm.