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Taxes lurk behind court test of Obama health law

WASHINGTON (Reuters) – While U.S. Supreme Court watchers focus on the controversial insurance requirement in President Barack Obama’s healthcare law, lesser known is that the court’s ruling next month will also decide the fate of billions of dollars in new taxes.

The 2010 law includes a 3.8% boost in taxes on investment income and a 0.9% increase in the Medicare payroll tax, both hitting people who earn more than $200,000 a year.

Set to take effect in 2013, the two increases have been called into question by the court case, which also has clouded the outlook for new provisions already in effect, such as a small business tax credit and a tax on tanning salons.

Whatever the ruling, it will be fodder for both political parties as they campaign in the final months before the Democrat Obama faces voters against likely Republican nominee Mitt Romney on Nov. 6.

The Supreme Court heard arguments in March on the lawsuit that contends Congress and Obama went too far in requiring Americans to hold health insurance by 2014 or pay a penalty – the core of the overhaul known as the “individual mandate.”

Its ruling is expected before the end of June.

“Most people aren’t aware of the tax provisions,” said Paul Sracic, political science professor at Youngstown State University in Ohio. “If the court decides against the individual mandate, the electoral consequences may hinge on the question of whether the entire law must fall.”

The healthcare law aims to expand coverage to 32 million more people by 2019, to more than halve the number of uninsured Americans. The Congressional Budget Office estimates it will cost $1.1 trillion over a decade.

That additional coverage will be financed largely through new taxes and fees needed to make up the difference between insurance fees and the rapid rise in healthcare costs.

Democrats are poised to criticize the conservative-leaning high court if it dismantles the law but leaves the taxes in place.

Republicans will swoop in on any decision that preserves tax increases on the wealthy. Some say they are worried that even if the mandate is struck down, major taxes will remain.

Christopher Condeluci, a Republican former tax counsel to the Senate Finance Committee, said the court could strike down the mandate only and leave the taxes in place for Congress to sort out.

Condeluci said he could envision a situation where the court effectively said: “Congress, you made this mess, you clean it up.”

POSSIBILITIES ‘ALMOST LIMITLESS’

Expected to issue its ruling in late June, the court could strike down the entire healthcare law, uphold the entire law, knock down only the mandate, or strike the mandate along with select other provisions.

“The range of possibilities is almost limitless,” said Alan Viard, a tax economist at the conservative think tank, the American Enterprise Institute.

A key issue from a tax perspective is whether the individual mandate is “severable.” That is: can it be detached from the rest of the law, including the tax elements, or are the pieces so intertwined that the entire law should be scrapped?

A business group and 26 U.S. states that brought the lawsuit say that if the court strikes down the mandate, the rest of the law would be “hollowed out” and untenable. Liberals lean the other way, saying parts of the law could work without the mandate.

Beyond meeting the costs of the healthcare law, the CBO estimated the new taxes would also reduce the federal budget deficit over 2012-2021 by about $210 billion, though that number is disputed by some who object to its basis.

HYBRID APPROACH?

In ruling on the lawsuit, the Supreme Court could take a hybrid approach to the tax issues. It might distinguish between provisions closely linked to the individual mandate and those that are not, lawyers and other experts said.

“That is where the uncertainty comes into play,” said Garrett Fenton, a healthcare tax lawyer at the law firm Miller & Chevalier. “Which provisions are they going to invalidate? The employer penalty? Tax credits for small business?”

That could mean that the tax provisions of the law most likely to survive a court ruling against the mandate would be those least related to healthcare. Examples of this might include the tax on investment income that kicks in next year.

Voters are sour on the individual mandate in some opinion polls, but other provisions in the overhaul are popular, such as a requirement that insurers provide coverage for young adults on parents’ plans and a ban on insurer discrimination based on pre-existing medical conditions.

“It is much harder to predict how the American people will view the tax breaks, particularly those for small businesses, that will also be struck down if the entire law is ruled unconstitutional,” Sracic said.

The wealthiest Americans would bear the heaviest burden of the law’s new taxes. The richest 1 percent, with average incomes of about $1.5 million, would pay an average $21,000 more in annual taxes under the law’s new investment and wage taxes, according to the centrist Tax Policy Center.

If the entire law or part of it is overturned, there is precedent for refunds, according to experts.

For tax breaks already in place, such as the small business tax credits, asking for retroactive payment may be politically unpopular, so Congress might step in and waive taxes owed, Viard said.