A tax or not a tax, that is the question

Summary: Under the Affordable Care Act (ACA), individuals who choose not to buy health insurance in 2014 or after will need to make a “shared responsibility payment,” which is called a “penalty” in the ACA. While I agree with most of the Court’s holdings, I do not agree with the finding that the penalty is a tax and is therefore constitutional. In my opinion, the Supreme Court’s ruling on the ACA is unfortunate, as it could legitimize less transparency in legislating rather than more.

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Most people do not like paying taxes, and most politicians don’t like to use the word “taxes”—unless they’re promising to lower them or simply taxing other people rather than their constituents. Under the Affordable Care Act (ACA), individuals who choose not to buy health insurance in 2014 or after will need to make a “shared responsibility payment,” which is called a “penalty” in the ACA. The Supreme Court held that the penalty functions as a tax, and Congress has the power to tax, thus making the individual mandate constitutional. I think this sets a dangerous precedent, but perhaps not for the reason most people would think.

Reading through the Supreme Court’s decision—the holding, the concurrence, and the dissent—is an interesting walk through constitutional history and analysis. For those who can’t sleep, it could be a good substitute for a warm glass of milk. In summary, the holding states that the individual mandate is not constitutional under the Commerce Clause because Congress can regulate commerce, but not compel people to engage in commerce. Also, the individual mandate is not constitutional under the Necessary and Proper Clause of the Constitution because the mandate is not necessary or proper in the furtherance of some other constitutionally allowed power. Because Congress wrote the individual mandate provision of the ACA such that individuals could choose to buy health insurance or pay a penalty, and that penalty functions as a tax (according to the Court), the individual mandate is constitutional as a result of Congress’s taxing power. In other words, because the penalty functions as a tax, the mandate is constitutional.

The Court also found that the federal government could not force states to expand Medicaid under threat of losing all Medicaid funding. Thus, states that opt not to expand Medicaid won’t have existing Medicaid funding withheld or reduced simply because they choose to not participate in the expansion of Medicaid.

‘Cause I’m the taxman

What I don’t like is that the tax is called a penalty in the legislation. It was sold to the public, and perhaps most members of Congress, as not being a tax. Deeming it a tax for constitutional purposes seems like a form of bait-and-switch.

Typically, I would expect the Court to evaluate the plain meaning of the text of the legislation when determining whether it is a tax. The fact that Congress specifically avoided the use of the word “tax,” and that the penalty was included in the operational portion of the legislation (Title I) rather than the revenue-raising portion of the legislation (Title IX), all point toward the fact that the penalty was intended to be a penalty, not a tax. Yet Chief Justice Roberts thought—perhaps correctly—that it was more important to put the most favorable construction on the provision to make it constitutional rather than the most obvious construction that was consistent with the intent of the legislators that passed the bill, which would have rendered it unconstitutional.

In my opinion, the Supreme Court’s ruling on the ACA is unfortunate, as it could legitimize less transparency in legislating rather than more. Most citizens are unlikely to read 900 pages of legislation and undertake a thorough analysis of whether a provision by another name functions as a tax. Words matter, and how a politician phrases something can make the difference between whether or not people understand it. I’m not afraid of living in Harrison’s world of Taxman as much as I am of living in Genesis’s Land of Confusion—partly because the puppets in the video scare me.   

The views expressed are as of 7-1-12 and are those of Chief Portfolio Strategist Brian Jacobsen, Ph.D., CFA, CFP^®, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.