Medicare funding shortfall may be ‘life and death’ for millions of Americans, lawmaker says. Here’s why taxes are a sticking point

Retirees who rely on Medicare for health-care coverage may see those benefits diminish in as soon as eight years.

“It’s life and death for millions of older Americans,” Sen. Sheldon Whitehouse, D-R.I., said last week during a Senate budget committee hearing titled “Medicare Forever: Protecting Seniors by Making the Wealthy Pay Their Fair Share.”

The program’s hospital insurance trust fund, which pays for Medicare Part A benefits including inpatient hospital care, may only pay 100% of benefits through 2031, according to projections from Medicare’s trustees.

If nothing is done by that date, just 89% of total scheduled benefits will be payable.

More from Personal Finance:
Here’s what happens to Social Security benefits after you die
As student loan bills resume, here’s how that may shake the economy
How Congress may fix looming Social Security benefit shortfall

Social Security faces a similar dilemma, whereby the program’s combined funds face a 2034 depletion date, at which point just 80% of benefits may be paid.

When it comes to repairing the programs’ funds, Congressional lawmakers generally have two choices: raise taxes, cut benefits or a combination of both.

“It’s simple arithmetic: raise revenue or cut benefits,” Whitehouse said of preserving Medicare.

“If we abide by what seemed like a bipartisan commitment not to cut benefits,” said Whitehouse, referring the State of the Union earlier this year, “we must safeguard Medicare by raising revenue.”

President Joe Biden prompted both sides of the aisle to agree to protect the safety net in his address to Congress in February.

Whitehouse, along with Rep. Brendan Boyle, D-Pa., has proposed the Medicare and Social Security Fair Share Act, which would require taxpayers with more than $400,000 in income to contribute more money to both programs.

The additional revenue would extend the solvency of the hospital insurance trust fund through the 75-year projection period in the 2023 trustees report, the Centers for Medicare and Medicaid Services Office of the Actuary recently estimated.

Yet not all lawmakers are convinced it is the right solution.

“We’ve got to work in a bipartisan fashion and keep a range of options on the table,” Sen. Chuck Grassley, R-Iowa, said during the hearing.

Whitehouse’s proposal calls for high earners to pay more into Medicare.

Currently, taxpayers with more than $250,000 in earned and investment income pay a 3.8% levy, known as the net investment income tax. The proposal calls for increasing that by 1.2% for incomes of more than $400,000.

The bill also calls for making those earning in excess of $400,000 to contribute Medicare and Social Security on pass-through business income. Currently, pass-through business owners such as hedge funds and private equity funds may avoid Medicare and net investment income taxes by treating their earned income as distributed business profits.

President Biden has also proposed raising the net investment income tax to 5% for earnings on more than $400,000 including pass through business income.

“The vast majority of Americans do, in fact, contribute to Medicare by taxes, either on income from their work or from their businesses,” said Chye-Ching Huang, executive director at the Tax Law Center at the New York University School of Law.

But wealthy filers may avoid those taxes by using a loophole that exempts income from pass-through entities used to own businesses.

“That invites hundreds of billions of dollars of wasteful tax avoidance,” Huang said. “Some of that tax avoidance gets so aggressive that it arguably becomes tax evasion because people are just not paying what they’re supposed to.”

Estimates have found closing the loophole may raise more than $300 billion, and 85% of that would come from people with incomes above $1 million per year, she said.

But the tax hikes in the proposal may have unintended consequences, Grassley argued.

The increased levies may not just affect high-income Americans, he said, particularly because the income thresholds will not be indexed for inflation. Ultimately, that may leave 25% of households affected by the end of the projection period, he said.

Instead, Grassley argued a better approach would be a bipartisan compromise.

“The truth is, taxes on the rich alone won’t save Medicare for our children and grandchildren,” Grassley said.