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Tuesday, March 30, 2010

Financial Ramifications of the Health Care Bill

March 30, 2010. Sausage and legislation are two things you never want to see being made. The big difference is I like sausage. 2,409 pages and 153 pages of amendments and we now have a health care bill. I don’t want to waste blog space with politics, so I’ll keep my political opinions to myself. On the other hand, the Bill has some pretty big financial consequences, which I’d like to address:

Taxes: The Bill increases taxes on households with income over $250,000. The first big increase is that in 2013, the Medicare tax rate for the over-$250,000 household goes from 1.45% to 2.35%. A 3.8% Medicare tax will be introduced for the over $250,000 on investment income (don’t ask me what investment income has to do with Medicare).

For 2011, the capital gains rates are expected to rise to 20% on households with AGI over $250,000. Add in the Medicare tax, and you have an effective rate of 23.8% on long term capital gains in 2013 (if you want to increase your annoyance, add in state income taxes as well). The current long term capital gains rate is 15%, so capital gains tax rates are prospectively increasing by about 58%. The amount received after taxes from a capital gain goes from 85% to about 76.2%, a 10.4% reduction in cash flow. This makes capital gains less attractive.

What’s the effect on stocks? According to David Kelly of JPMorgan, half the stocks are owned by households under $250,000 and half are owned by non-taxable accounts (so roughly one-quarter are owned by high-income individuals in taxable accounts). He sees the prospective effect on stocks to reduce the value by 2.6%. Not enough to warrant bailing on stocks. Bonds don’t fare any better: right now the maximum rate on taxable interest (like the remarkable 0.7% you’re making on your bank account) is 35%. If we look at the 2011 changes (expiration of the Bush tax cuts), then add in the Medicare tax in 2013 the new rate will be 43.4%.

One investment spot that will benefit is municipal bonds. Take a muni bond with a yield of 3.8%. To a taxpayer in the 35% bracket, this is the equivalent of a 5.8% taxable bond (more if it’s a state specific bond). Under the probable new rules in 2013, the taxable equivalent yield on that same muni will be 6.71%. The muni is worth 15.7% more to the high bracket individual.

Drug Companies: Drug companies seem to clearly benefit from the Bill. (I think they should call this the “The Insurance Company and Drug Company Profit Enhancement Act” The ‘donut hole’ in Medicare coverage is removed by 2020. There is an excise tax on medical devices of 2.9% (glad I bought my hip joint in 2008). Drug companies also now get protection from generic drug manufacturers as well (oink). In addition, the Bill pretty much expands coverage without really cutting costs, so medical care companies and drug companies now have a bigger pool of customers. Some commentators think doctors will be OK, I really don’t think the physicians will benefit as much.

Economy: Since most of the tax increases don’t kick in until 2013, and most of the mandates don’t kick in until 2016, I don’t see doom and gloom on the economy. I believe that we’re on the front of a massive global expansion. Health care spending is obviously a decision that our elected officials have made. This may cost businesses, but that can always be adjusted in the wages paid to workers (in other words, you get health care instead of more pay). Capitalism is resilient.

Bottom Line: This Bill did nothing to contain costs:

• It didn’t reform the medical malpractice rules (which probably cost about 10%);
• It kept the drug companies on long patents and protected them from generic manufacturers;
• It ignored the most expensive part of medical care: the last year of life;
• It ignored the premise of preventative health care;
• There’s nothing to encourage the consumer to save costs.

The US spends about 16% of our GDP on health care, 45% more than the country which has the next highest spending (France sacre bleu!). Our life expectancy is 38th in the world. Maybe a better approach would be getting people to take care of themselves as a health care measure.

Stay Healthy,

Leon