How will we pay for health care reform? An increase in Medicare tax

As the House prepares for a vote on health care reform, the overwhelming question is how to pay the estimated $940 billion price tag on the plan. The obvious -- but not so politically popular -- answer is to raise taxes. Even better? Raise taxes so taxpayers don't notice it as much by including it in mandatory withholding.

That explains why the current proposal in the House under HR 3590 would add an increase in the form of payroll taxes. The bill, as it stands currently, would add .9% to the Medicare payroll tax to those individual taxpayers earning over $200,000 ($250,000 for married couples filing joint tax returns). That would bring the total tax rate to 2.35%.

The current Medicare payroll tax rate is 1.45% and is part of what we know as FICA, or Federal Insurance Contributions Act tax. The tax is imposed on employees and employers to fund Social Security and Medicare. Since it's imposed on only those who work, the tax has been quite controversial. Unearned income, including interest, stock dividends, and capital gains such as profits from the sale of stock or real estate, are not affected by this tax.

An alternative proposal would increase the tax rate and extend a 2.9% tax rate to include unearned income. This version is favored by President Obama and many Congressional Democrats. As of this writing, it is not expected to be included in the version of the bill taken up for a vote by the House. While the final vote remains to be seen, most pundits expect that the House would approve the health care bill passed by the Senate in December, with any changes implemented using a procedure known as budget reconciliation.

Since most taxpayers would not be affected by the increase, the measure passed easily in Senate at the end of 2009. The final vote was 60 yes, 39 no and 1 abstention: Sen Jim Bunning (R-Ky.) did not vote, citing "family commitments." Interestingly, the final version of the Senate bill tapped the increase at a higher rate than the original proposal: earlier versions called for an increase of just .5%.

If the measure passes the House (and this measure is expected to survive any last minute deal-making), the bump in rates would take effect after Dec. 31, 2012.