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161 IRET Congressional Advisory 1 (2003)

handle is hein.taxfoundation/iretcgadv0158 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. October 17, 2003 Advisory No. 161 PRESCRIPTION DRUG MEANS TEST MEANS HIGH MARGINAL TAX RATES Executive Summary Means testing has been suggested to bring down the costs of the prescription drug bills. That may be necessary, but income tests have the effect of imposing severe tax penalties on earning additional wages or saving for retirement. That is certainly true in the House and Senate drug plans, which provide special low income benefits (waivers of premiums and deductibles, and reduced copayments) that are withdrawn as incomes rise. Similarly, the asset tests in the bills would encourage low income people to spend down, give away, or hide their excess assets, rather than lose the substantial low income subsidy year after year. Likewise, the limitation on the catastrophic drug expense benefit for upper middle income seniors in the House bill would create an implicit marginal income tax rate spike and discourage work effort. Plans by the House-Senate conference on the bills to add additional upper income means testing would exacerbate these effects. Consider a participant under the Senate bill whose income is $12,906 (135% of the projected 2006 poverty level), and who spends $4,500 on drugs: If he earned an extra $2,400 or withdrew that amount from an IRA, he would lose $2,571 in waivers of low income premiums and copayments. That's an implicit tax of 107 percent of the added income. If his drug spending were at the catastrophic spending threshold of $5,813, he would lose a $3,752 subsidy by earning $2,400 more income, an implicit tax rate of 156%. For upper income seniors, the out-of-pocket requirement for triggering catastrophic benefits under the House bill rise by $8,100 as income grows from $60,000 to $200,000, an implicit add-on marginal tax rate of 5.83%. With federal and state income taxes and the payroll tax, working seniors could be paying 43 percent to 50 percent tax on their added income. Many Medicare recipients choose not to work, and those with very high requirements for prescription drugs may be too ill to work even if they wanted to. Nonetheless, the added disincentive effect of high implicit tax rates under the catastrophic drug feature could discourage others who wish to work from doing so. The presence of means testing also dis-rewards those who save for retirement.

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