Why a lot of health reform's costs could be borne by the middle class, despite Obama's pledges

By Jane Sasseen

As a candidate and President, Barack Obama has had one core message for the middle class: I won't raise your taxes. The White House has pledged that only the wealthy—families earning more than $250,000—would face a boost in income, capital gains, or other taxes. For the 97% of Americans below that level, no increases are in store.

But as Congress inches closer to forging a massive package of health-care reforms, it's increasingly clear how difficult it will be to keep that pledge. To pay for the near trillion-dollar health-care system overhaul—not to mention reining in the deficit and funding other ambitious plans Obama has laid out for the years ahead—many outside the White House believe the middle class will not be spared. Republican critics contend that the White House is misleading the public about who will ultimately shoulder much of the cost of extending coverage to tens of millions of uninsured Americans.

True, most won't see direct tax hikes, per se. Few believe Obama will go back on his vow to keep income tax rates the same for all but the top brackets when the Bush tax cuts expire at the end of 2010. And top White House economic adviser Lawrence H. Summers says Obama can keep his pledge while finding more than enough cost cuts and revenue elsewhere. "There is substantial scope for expenditure reductions in health care and for raising enough revenues from people with incomes over $250,000 and from companies," he says.

A key question, though, is whether over the next couple of years, middle-income families will face a host of surcharges, fees, reduced tax breaks, or other increased costs. Daniel Clifton, a Washington-based policy analyst for Strategas Research Partners, argues that Congress has purposely loaded onto the corporate sector the increased taxes needed to pay for the reforms to avoid politically unpopular individual tax hikes. But the added costs will eventually be shifted to customers. "It all depends on what your definition of 'tax' is. Everyone is mincing words here," says Clifton. "There isn't enough money available in just extracting more from corporate taxes or rich Americans."

Consider the Senate's proposal to impose a 40% excise tax on so-called Cadillac health insurance plans valued at more than $21,000. The idea, say backers, is to discourage the excessive health-care spending said to result from such generous plans. The proposed tax on the plans would raise $202 billion, more than half the new funds needed to help pay for extending insurance coverage. Rather than tax policyholders directly, the hit would be on insurers who offer those plans.

Worried Unions

The insurers, though, likely will cut benefits or raise premiums as a result. That point hasn't escaped union leaders, who oppose the proposal because it would target many of their members, who have negotiated generous health benefits. Richard L. Trumka, the head of the AFL-CIO, argues that roughly 15% of insured families and 19% of individuals—most solidly middle-class—have plans that would fall under the new tax. For many members, he says, the result would be higher medical costs. "What [they are] actually saying is that cost of covering the uninsured should be borne by the middle class," Trumka says.

Summers counters that the tax is intended to curb wasteful health-care spending; the goal, he says, is to get employers to offer less pricey insurance policies and raise wages instead. But labor leaders remain unconvinced, and they're lobbying to kill the measure. GOP opponents of the reforms have also intensified their attacks. Senator Chuck Grassley (R-Iowa), the ranking Republican on the Senate Finance Committee, argues the pending bills would leave many worse off. "The vast majority of middle-class Americans would pay higher taxes and premiums," he says. He, too, cites the Cadillac tax increase, along with other changes such as a rise in the threshold on deductions for medical expenses from 7.5% of adjusted gross income to 10%. Quoting figures compiled by the bipartisan Joint Committee on Taxation, he says that by 2019, when the bill would be fully in effect, families earning over $75,000 would see a net hike in taxes.

On another front, the Senate is counting on hefty excise taxes assessed on the different players in the medical industry for a big chunk of funding. Altogether, insurers, drug companies, and device makers could be on tap for roughly $120 billion in fees over the next decade. Problem is, a big portion of those taxes are likely to be recouped in the form of higher prices or increased premiums. "It's a fiction," says Roberton Williams, a former Congressional Budget Office official now with the nonpartisan Urban Institute's Tax Policy Center. "The excise taxes won't be paid by the companies; they'll be passed right back to their customers."

Summers disputes that notion and argues that the excise taxes "are designed so they will likely be difficult to pass on." And he points out that the estimates Grassley cites do not take into account expected cost savings and other benefits of reform. "Many of those same firms will no longer have the burdens associated with paying for uncompensated care," he argues.

However the numbers are sliced, they add up. All told, by imposing new taxes on health-care providers, the Senate Finance Committee is counting on raising some $340 billion to help pay for reforms. An additional $42 billion would come from trimming tax breaks for such things as health savings accounts and medical expenses, according to fiscal watchdog US Budget Watch. It remains to be seen how much of that tab average Americans will end up shouldering.

Sasseen is Washington bureau chief for BusinessWeek.