Tax Dodging

Why it matters whether we call the health insurance penalty a “tax” or a “fee.’

President Barack Obama 

Last week, President Obama found himself caught up in Washington’s favorite word game. The rules: Find as many ways as you can to describe your taxlike policy without using the word tax.

The policy in question? The requirement in both the House and Senate health care bills that everyone buy health insurance. Anyone who doesn’t buy it has to pay a fine—$750 per person if your income is up to three times the poverty level or $950 if you make more than that.

“For us to say you have to take responsibility to get health insurance is absolutely not a tax increase,” Obama said on ABC’s This Week on Sept. 20. George Stephanopoulos responded by whipping out a copy of Merriam-Webster’s dictionary and reading aloud the definition of tax. Obama stood his ground: “Nobody considers that a tax increase.”

Unless you count Republicans. Sen. John Ensign of Nevada introduced an amendment to the finance committee legislation that would replace the word fee with tax every time it appeared. The RNC produced a Web video featuring the Stephanopoulos exchange, and Chairman Michael Steele is holding a press conference Tuesday to discuss “President Obama’s proposed health care taxes.”

Who’s right? Some tax policy analysts dismiss the question as merely academic. “It’s a distinction without a difference,” says Robert Moffitt of the Heritage Foundation, calling the question a “metaphysical” one. “It becomes semantics as much as anything,” says Bob Williams of the Tax Policy Center.

Yet there is a generally accepted definition of taxes vs. fees, says Joseph Henchman of the Tax Foundation: Taxes are used to fund services for everyone. Fees compensate the government for services that benefit a particular group. “The question is what the revenue is for,” Henchman says. “If it goes for providing services for the general public, then it’s taxlike. If it’s to compensate for the costs of punishing individuals for not buying insurance, then it’s feelike.” The Baucus bill would use the payments to help subsidize coverage for the uninsured, which Henchman says would make it more “taxlike.”

Still, those rules have enough exceptions to make them almost useless. Consider the gas tax. It’s levied on a portion of the population—drivers—and usually used for a particular service—repairing roads. Yet it’s still called a tax. Meanwhile, taxes on fishing and hunting are often used to fund general services but are usually called licensing fees.

Perhaps the best people to ask would be the members of Congress themselves. The House bill, for example, refers to the fine as “tax.” The Baucus bill calls it an “excise tax.” Plus, the decision to have the Internal Revenue Service collect the payment through its regular methods doesn’t exactly dispel the notion that it’s a tax. “I don’t know of anything the IRS does to collect money from people that’s not a tax,” says Williams.

Obama is hardly the first politician to fudge in order to avoid the T-word. Minnesota Gov. Tim Pawlenty proposed slapping a 75-cent “health impact fee” on packs of cigarettes in 2005. That way, he wasn’t breaking his promise not to raise taxes. Democrats in the California Assembly are determined to call a $1 surcharge on automobile registrations a “fee,” while Republicans deem it a “tax.” In Virginia, meanwhile, the two gubernatorial candidates are quibbling over whether a gas tax is really a tax. Creigh Deeds says when he promised not to raise taxes, he meant he wouldn’t raise taxes for the general fund—not dedicated taxes like the gas tax. (Watch him dance here.)

All this hemming and hawing occurs for a reason: It does, in fact, matter whether we call the fine a fee or a tax, especially when it comes to health care. First and most obvious is the politics. During the campaign, Obama promised not to raise taxes on the middle class, which he has since defined as any household making less than $250,000 a year. If his opponents can successfully paint the individual mandate as a tax hike that falls squarely on the middle class, they can then bust out their other favorite three-letter word. Played right, this strategy could make Obama look like the second coming of George H.W. Bush.

The definition also matters because taxes and fees have different legal meanings. Many states, for example, have special requirements for a tax hike: Some require a supermajority of legislators to vote for it or for multiple readings of the bill. In California, it requires voter approval. The distinction could also matter on the federal level. On Friday, Sen. Ensign pointed out that if the fee is indeed a tax, wouldn’t someone who refused to pay it be considered a tax evader and therefore subject to an even larger fine? A representative from the Joint Committee on Taxation said that yes, the penalty for failing to pay the fee could be as high as $25,000 and up to a year in jail. The likelihood of every scofflaw paying that penalty is extremely low, says tax law professor Joseph Bankman of Stanford University: “There’s no reason you’d have to stick with existing penalty structures.” But it shows how a tax vs. a fee is a distinction with a difference.

That distinction could even have implications for the constitutionality of health care reform. Some lawyers have raised concerns that the individual mandate may overstep Congress’ constitutional authority to regulate commerce and levy taxes. The flipside of that argument, however, is that, in the likely event of a court challenge, the administration wants as many defenses as possible. The first line of defense would be the commerce clause, which regulates the trade of goods and services across state lines. The administration could say that it applies to health care because when people don’t buy health insurance, it affects everyone else, even in other states. The second argument, if necessary, would be that Congress has the right to tax the people. In which case, the administration might want to describe the individual mandate as a tax.

Naturally, politics will win out. Democrats will fight the “tax” label. And with good reason: If the bill can’t get enough votes because of fears that it’s a tax hike, Democrats won’t even get a chance to test its constitutionality. And if a bill doesn’t pass, Democrats up for re-election could pay the ultimate fee. I mean, tax.