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Justice Roberts is Right: The Plan Won't Work
Posted by Peter Schiff on 07/30/2012 at 5:25 PM

Now that the Supreme Court has given its narrow blessing to the Affordable Care Act, the big question is whether it will deliver the benefits that its proponents promise. Unfortunately, as it is now constructed, the plan will backfire causing fewer healthy people to buy insurance, raise premiums for those who do, destroy employment opportunities, cripple the health insurance industry, and weaken the economy.

In order to guarantee insurance to all, regardless of age, health or pre-existing conditions, the framers of the plan concede that it is essential that the young and healthy (who are less likely to be heavy users of health care) pay into the insurance pool. The surplus generated from their premiums compensates for the money lost to those receiving more in services than they pay in premiums (e.g. older people and those with medical conditions). But the ACA has given these healthy people a "Get out of Jail Free" card that many of them are sure to play.

Most healthy young people know that they are losing money to insurance providers, at least in the near term. That is the nature of insurance.  You pay to prevent costly exposure to an unlikely event. And just as homeowners wisely pay for fire insurance even though they don't expect their homes to burn down, given the high cost of medical care it is also practical that healthy young people buy health insurance.

But, the ACA makes it illegal for insurance providers to deny coverage to anyone for any reason. This allows healthy people to drop insurance until they actually need it without incurring any risk. It's like allowing homeowners to buy fire insurance after their houses burn down.  To counteract these new free rider incentives, the law imposes "no insurance" penalties (also defined as taxes by the Supreme Court). The problem is that these "penaltaxes" (for lack of a better word) are insufficient to the task. In fact, Chief Justice John Roberts ruled the law constitutional precisely because the burdens were not high enough to compel behavior. (In other words, he thought the law was constitutional because it will be ineffective.) The numbers support his arguments.

On average, in 2010, a typical healthy young person paid at least $2,500 per year for insurance (for a plan that would still involve significant out of pocket expenses). In some areas of the country, premiums were more than twice as high.  When the program takes effect in 2014 the penaltaxes will be the greater of $95 or 1% of household income. A single person earning $40,000 per year who chooses to go uninsured would then be subject to a $400 penaltax. The decision would be an easy one: drop the insurance, incur the penaltax and pay for any routine medical services out of pocket.  In the unlikely event that he gets cancer or is hit by a bus, he can always buy insurance in the ambulance on the way to the hospital.  Even in 2016, as the penaltax increases to the greater of $695 or 2.5% of household income, it will still not make sense for many people to buy insurance. The penaltaxes are capped at levels that equal the full cost of an average health plan.  So even high income individuals are no worse off financially for not buying insurance. In addition, the IRS' ability to actually collect these penaltaxes is limited to garnishing income tax refund checks. If an individual is not getting a refund, the IRS is impotent.  

The law places no requirements for businesses with fewer than 50 employees to offer insurance. So when younger workers realize the benefits of dropping insurance, they will naturally gravitate to savvy businesses that offer higher pay instead of insurance. This will drain more premiums from the insurance pools. 

In contrast, the burdens placed on employers with more than 50 workers are complex, onerous and unpredictable. Those that don't offer insurance would be subject to substantial (and open ended) penalties if at least one employee receives an insurance tax credit or a government subsidy to an insurance exchange. If they do offer insurance, they will also be subject to substantial (and open ended) penalties if the plan fails to cover 60% of employee health expenses, or if premiums for any employee are more than 9.5% of family income.  It has been left wholly unexplained how employers are supposed to accurately determine these triggers which involve knowledge of family income, not just employee income.

Smaller employers will look to avoid these headaches by staying below the 50-employee threshold. Though it should be obvious, there is plenty of evidence to support this tendency. French law involves significant regulatory requirements for businesses that have more than 50 employees.  As a result, there are currently 2.4 times more French companies that have 49 employees than there are with 50. Incentives for businesses to stay small will hurt the economy and will further shrink the numbers of people paying into the health insurance pools.  

Employers will also be incentivized to avoid hiring lower paid workers who would be more likely to trigger the penalties tied to household income. As a result, many small companies will likely look to replace lower rung employees with temps, automation or outsourcing, further raising the barrier to workforce entry for lower skilled workers. The unemployable workers will then qualify for free health insurance, further draining the system.

Unless the penaltaxes are raised significantly, far too many needed premium payers will drop out.  As they do, insurance companies will try to recoup the lost revenue by raising premiums for the customers who remain.  As the gap between the relatively low penaltaxes and the high cost of health insurance premiums increases, so too will the incentive to drop coverage. This self-reinforcing dynamic will render the entire plan non-viable.

It is a foregone conclusion that the Obama Administration and its congressional allies are already planning to raise the penaltaxes. Although such increases would render the plan unconstitutional if they compel behavior, according to Roberts's analysis, I do not expect the Supreme Court to ever rule on this case again. The Court has a history of opening small cracks in the Constitutional barn door for the bureaucratic horses to stampede. 

Unless we can summon the political will to repeal the poorly conceived law, we should all brace for higher health care costs, many more layers of impenetrable federal bureaucracy, a significantly weaker economy, diminished employment opportunities, and lower living standards.


Tags:  Constitutionhealth insurancehealthcareobamacaresupreme court
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Supreme Error
Posted by Peter Schiff on 07/03/2012 at 10:09 AM
In the wake of my last commentary on the horrendous Supreme Court decision upholding Obama’s health care plan, several people have pointed out that I erred in saying that the income tax is a “direct tax.” While it is technically correct that the Court ultimately declared it to be an excise, not a direct tax, it is important to understand how it arrived at that opinion and why the decision has no practical relevance to the way the tax has been enforced.   Just as it has done with Obamacare, the Court concocted a technically constitutional pathway to allow the government to collect a tax in a blatantly unconstitutional manner.

In the 1895 Pollock v. Farmers’ Loan and Trust case, the Supreme Court declared the original Income Tax of 1894 unconstitutional because it imposed a direct tax that was not apportioned to the states according to the taxing provisions of the Constitution. For example it said that a tax on rental income is the same as direct tax on the property that produced the income.  In other words, a tax on income was tantamount to a tax on its source.

To get around this, in 1913 Congress passed, and the state governments ratified, the 16th Amendment that authorized a tax on income from whatever source derived without regard to apportionment.    However, in 1916 the Supreme Court ruled in Brushaber v. Union Pacific Rail Road that the Amendment “conferred no new taxing power to the Federal government,” and that it “contained nothing challenging or repudiated its ruling in the Pollock case.”  Instead, the Court said that in order to be constitutionally taxed as an excise, income must first be separated from its source.  A few years later in Eisner v. Macomber (1918) and Merchants Loan and Trust v. Smietanka (1921) the Court provided a practical guide to doing just that, by defining income, for purposes of the Sixteenth Amendment, as a corporate profit.

A corporation determines profit by subtracting its expenses from its income. The difference, called profit, could then be subject to an income tax.  So if a corporation has rental income, but derives no profit after backing out all of its expenses, then the rents, and therefore the property, are not taxed.  In that respect, the income is separated from the sources that produced it.  Were it not for this separation, a tax on rents, dividends, fees, etc. would be a direct tax on the sources of income, as described by Pollock, Brushaber, Eisner and Smietanka.  That is why many U.S. corporations can have billions of dollars of income but pay no tax, because they derive no profits from that income.  This proves the income tax is, in reality, a profits tax.  The problem is that the modern income tax is not merely being levied as an excise tax on corporate profits, but as an unapportioned direct tax on the personal income of every American.    This is precisely what the Supreme Court has repeatedly held to be unconstitutional.   Yet lower courts have serially ignored the reasoning behind these Supreme Court decisions and have allowed the Federal Government to impose a tax in the precise manner that the Supreme Court ruled it lacked the constitutional authority to do.

The Founding Fathers made it difficult for Congress to levy direct taxes because they considered the more easily avoidable excise taxes to be self-correcting as to abuse.  They also wanted to make it more difficult for poorer states to vote for taxes that would be paid disproportionately by wealthier states.  As a result, they believed that during peacetime the Federal Government would rely primarily on excise taxes and would resort to direct taxes mainly during wartime.

To levy an apportioned direct tax on personal income, Congress would first have to decide how much it wanted to raise and then assign each state its pro-rata share. So a $1 trillion dollar income tax would require Mississippi and Connecticut (each with about 1% of the U.S. population) to pay about $10 billion. However since per capita income in Connecticut is 80% higher than it is in Mississippi, federal income tax rates in Mississippi would have to be 80% higher than the rates in Connecticut.  This makes it less likely that Mississippi would support such a tax. But given the way the income tax is currently enforced, Mississippi happily votes for levies that fall predominately on residents of wealthier states. This is precisely what the Constitution was written to prevent.

Just as a tax on land based solely on its rental income is the same as a direct tax on the land itself, a tax on individuals based solely on their decision not to buy health insurance is a direct tax on individuals.  To get around this, Chief Justice Roberts ruled that the new healthcare tax is indirect because not everyone will have to pay it. However, the percentage of people ultimately subject to a tax does not determine into which category it falls.  Less than two percent of Americans were subject to the original income tax, yet the court still viewed it as a direct tax.

The bottom line is that the Supreme Court has a history of giving the government latitude to get around the Constitution.  Instead of looking at the intent of legislation (even when the legislators are alive to be asked), or even its practical effect, the Court looks for any legal technicality upon which to base a ruling of constitutionality.  That is what happened with the income tax, and is now occurring with the Affordable Care Act.  Had the Supreme Court been more forthright with the income tax, the country would not now be suffering from a destructive and pervasive tax that was originally intended to be a small levy targeted only at the top 1% of American earners.

Remember, the Court’s sole rationale for ruling the exactions in the Affordable Care Act are taxes rather than penalties was its belief that the taxes are too low to actually compel anyone to buy health insurance.   This made it consistent with the Court's view that Congress lacks the authority, under the commerce clause, to compel Americans to buy health insurance.   If the Court believed that the tax was actually high enough to leave Americans with no rational choice, Roberts would have ruled it unconstitutional .

The observation that the penalty is too low to work may be the one thing the Court actually got right. However, once the government realizes that it has underpriced the fines, it will certainly raise the tax rate substantially to stop healthy people from rationally dropping their coverage (because insurance companies could not deny them similarly priced coverage after they got sick).   Just as they routinely do now with respect to the income taxes, the lower courts will likely misinterpret the Supreme Court’s ruling and rubber stamp any future rate hikes.  For political reasons it is unlikely that a Constitutional challenge to such an increase will ever make it back up to the Supreme Court.

This leaves us few good options. Unless Congress repeals the legislation quickly we will likely have to live with it for a long, long time. Sadly, despite the Romney and the Republicans’ promises to do just that with election victories this fall, there is virtually no precedent for government giving up a power that it has fought to take. In the end Americans will be forced to purchase health insurance in the manner the Supreme Court just ruled to be unconstitutional.


Tags:  Constitutionobamacaresupreme courttax
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Legal Gimmickry Rescues Obama
Posted by Peter Schiff on 06/29/2012 at 11:04 AM

Despite the celebrations among Democrats, yesterday a majority of Supreme Court justices ruled that the Constitution does not allow the government to force Americans to buy health insurance. However in providing the swing vote to uphold the Affordable Care Act (aka Obamacare) Chief Justice John Roberts broke with the four other justices who shared that view by declaring that the methods chosen to get individuals to buy insurance were not penalties but taxes. He declared that the government wasn't legislating behavior, but simply taxing it. In reaching this tortured decision he erred by declaring the penalties to be taxes and then compounded the mistake by classifying them as "indirect taxes" that are not imposed on individuals. Apparently Roberts feels that these two wrongs will make a right. But his mistake will cost this country dearly.

The Obama administration admits that because the law makes it illegal for insurance companies to discriminate based on pre-existing conditions it eliminates the incentive for healthy people to buy insurance. Any rational healthy person would simply forego expensive insurance until they were old enough or sick enough to actually need it. Since insurance companies need the money they make from healthy people to compensate for the money they lose from sick people, the plan would collapse if the government did not devise a mandate that would convince or compel all individuals to buy insurance.

In selling the plan to the public, President Obama repeatedly claimed that these burdens were penalties, not taxes. In addition to the stated intent of the lawmakers, the standard legal definitions that separate taxes from penalties make it clear that the new financial burdens are penalties, not taxes. A tax is an exaction to raise revenue. If its primary purpose is to compel behavior then it is considered a penalty. 

But Roberts argued that since the "tax" on not buying is lower than the actual cost of insurance, then the penalty will not force anyone to buy. He did not specify a level at which the "tax" would become determinative thereby becoming an unconstitutional penalty. However, since Congress can raise the tax anytime it wants, the mechanism is already in place for it to do exactly what the Supreme Court ruled it can't. Does Roberts expect to review the case every time Congress raises the penalty? The fact that Roberts feels that the penalty is ineffective is irrelevant. It is not the Court's job to judge the efficacy of legislation, just its constitutionality.

Robert's conclusion that the Federal government can't require that people buy health insurance but can impose a tax on those who don't is a distinction without a difference. After all, if the tax was high enough, individuals would have no choice but to comply. It has been clearly established that Congress can't do with the tax code what it lacks the constitutional authority to do with legislation. That is why the Constitution had to be amended in order to ban the sale of alcohol. Prohibition would have been much easier to achieve by simply raising alcohol taxes sufficiently to eliminate its sale. But such a tax would have been unconstitutional. The same principal applies to health insurance. Congress can't simply use taxes to force Americans to buy health insurance.  

Even if you buy Robert's logic that the penalty is a tax, he still should have ruled it unconstitutional because all direct taxes, except income taxes as described by the 16th Amendment, must be apportioned. The government's power to tax is not absolute. Taxes fall into two classes, direct and indirect, and there are specific rules for each. Alcohol and tobacco taxes are indirect taxes, and are subject to the rule of uniformity. You only pay them if you buy the products, and you do so indirectly through the merchants who sell them. If you do not buy the products you pay nothing.

However, the only way to avoid paying the tax for not buying health insurance is to buy a product that you do not want. So either way you pay. And since the taxpayer pays the tax directly to the government, it's a direct tax, which must be apportioned by state according to each state's percentage of the nation's total population.  

Roberts allowed the government to free itself from this straightjacket by redefining the meaning of a direct tax. He asserted that the tax for not buying health insurance is indirect because it affects not all Americans but only those who fail to buy health insurance and who have sufficient income to pay.  But the percentage of people who are subject to a tax has nothing to do with the class to which it belongs. The 19th Century income tax was declared unconstitutional because it was an unapportioned direct tax. The fact that less than 2% of the population was initially subject to it was beside the point.  

As with Prohibition, to impose an unapportioned direct income taxes on individuals the government had to amend the Constitution. It should have to do it again to impose another unapportioned direct tax on those who fail to buy health insurance.

The Supreme Court has ruled (incorrectly in my opinion) that estate and gift taxes fall into the category of indirect taxes, even though they are paid directly to the government. The court ruled that these are not direct taxes on individuals, but excise taxes levied on the privilege of giving gifts or bequeathing property. They could try to apply the same twisted logic to health insurance, but it would be quite a stretch to classify the right not to buy health insurance as a privilege.

In the final analysis, since the court ruled that the government cannot force Americans to buy health insurance, and that the stated purpose of the Affordable Care Act is to do precisely that, it is clearly unconstitutional, regardless of the legal trickery the court used to declare otherwise.

If the government had tried to slip an unconstitutional penalty by the Court by disguising it as a tax, then Obama may have been on the wrong end of yesterday's decision. Instead he chose a losing argument but Roberts found a loophole to uphold it anyway. Despite his stated preference for restraint, this is the ultimate in judicial activism. This awful ruling makes it more evident that the ballot box provides the only remedy for freedom loving Americans. 

I offer more on this topic in my latest video blog.



Tags:  health insurancehealthcareobamaobamacaresupreme court
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Unprecedented Presidential Posturing
Posted by Peter Schiff on 04/12/2012 at 11:35 AM

Last week, responding to President Obama's latest populist assault on the wealthy, I issued a commentary in which I explained why his ideas about American economic history were fundamentally flawed. As dangerous and erroneous as those views are, at least I can cut the President some slack for commenting on a subject in which he really has no basis for expertise. Hailing from academia and local community organizing, Barack Obama likely did not spend huge amounts of time boning up on economic history. However, there are other subjects where he should find firmer footing. Constitutional law certainly comes to mind. After all, Obama rose to national prominence based on his status as a legal scholar. He graduated magna cum laude from Harvard Law School, where he was elected president of the prestigious Harvard Law Review. He went on to teach constitutional law at the University of Chicago Law School, one of the top ranked schools in the country.

 

Based on these achievements, it is simply stunning that he made so many fundamental errors last week in his analysis of the Supreme Court's review of his sweeping health care legislation. Not only did he make grossly inaccurate statements with regards to the health care legislation, and the history of Supreme Court decisions that relate to it, but he also showed little understanding of the very purpose that the Court serves within the constitutional framework of the U.S. government. These remarks either indicate that a Harvard degree isn't worth the paper it's written on or that there is nothing Obama won't say to advance his political agenda.

 

In his apparently off-the-cuff remarks he stated that "I'm confident that the Supreme Court will not take what will be an unprecedented, extraordinary step of overturning a law that was passed by a strong majority of a democratically elected Congress." Before even turning to the more nuanced parts of that statement, I would ask the President what he considers to be a "strong majority?" His health care legislation (dubbed "Obamacare" by Republicans), passed the House of Representatives in March 2010 on a nearly party line vote of 220-221 (some would call this result "a squeaker.") What's more, just six months later, the slim majority that voted to pass the legislation was voted out of existence. Not only would the law stand no chance of passage in the current Congress, the majority of Americans still show misgivings about the expansion of federal power that the law involves.  So much for a groundswell of national support. But that's just the appetizer.

 

Obama claimed that it would be "unprecedented" for the Supreme Court to overturn a law passed by Congress. Is he kidding? Every seventh or eighth grader who has taken a civics course knows that the Supreme Court acts as a check on the executive and legislative branches of government (who can often disregard the Constitution in their quests for votes and power). The intent of the framers of the constitution was affirmed in 1803 by the landmark case "Marbury v. Madison" in which Chief Justice John Marshall established the doctrine of "judicial review," whereby the Court can strike down any law that it feels to be unconstitutional.  Is it possible that they never got around to that case at Harvard?

 

Since Marbury the Supreme Court has undone sweeping economic policies many times. Perhaps the most significant example was in 1895 when the Income Tax Act of 1894 was undone by Pollock v. Farmers Loan and Trust. By ruling that the new income tax did not conform to the taxing powers delegated in the Constitution, the Supreme Court derailed the revenue seeking agenda of the federal government. Proponents of the tax had to revert to the constitutional amendment process, a workaround that took 18 years and ultimately resulted in the 16th Amendment.

 

Forty years after Pollock the Supreme Court struck again when it invalidated the National Recovery Act (NRA), Franklin Roosevelt's signature piece of Depression Era legislation. The NRA was truly an "unprecedented" intrusion into the commercial lives of Americans which injected U.S. government micromanagement into almost every facet of commercial activity. It told merchants and industries how much they could charge for particular products, how much they should pay workers, how long workers could work, how employers could negotiate with unions, and established "codes of fair competition" for all business to follow. 

      

In a unanimous decision in the 1935 Schechter Poultry Corp v. United States, the Supreme Court threw out the NRA. The Court ruled that the Act's draconian economic engineering was too broad an interpretation of the Constitution's infamous "commerce clause." After the ruling, Justice Louis Brendeis (not known for his strict adherence to conservative constitutional interpretation) famously remarked to a presidential aide, "This is the end of this business of centralization, and I want you to go back and tell the President that we're not going to let this government centralize everything." Wow, President Obama, now that's a whole lot of precedent.

 

What is perhaps even more shocking than Obama's ignorance on these subjects is the media's reluctance to really hold his feet to the fire. Imagine if Sarah Palin had made similarly ignorant statements during the presidential campaign of 2008. She would have been absolutely crucified in the press for her lack of understanding of the basics of federal checks and balances. But Sarah Palin would have had an excuse, she was a sports reporter, turned small town mayor, turned one-term governor of Alaska. She never taught a class in constitutional law at an elite law school.   

 

Although subsequent statements by the President and his spokespeople have attempted to "clarify" (and soften) his originally indefensible remarks, the impression he made will be hard to erase. My hope is that his attempt to intimidate the court into upholding his law will backfire, and what is left of judicial independence will save us from Obama's impractical health care plan. If so we will have John Marshall to thank. 

 

To save 35% on Peter Schiff's new book, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Countrypre-order your copy today

 

For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.



Tags:  congressobamasupreme court
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