Health tax is in flux. Now what?

The idea of taxing health benefits isn't dead yet, but lawmakers are seeking support for other ways to pay for health reform. No option is likely to be popular.

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NEW YORK (CNNMoney.com) -- Lawmakers searching for a way to pay for health care reform are facing some rough waters.

Very rough.

Sen. Max Baucus, chairman of the Senate Finance Committee, has said repeatedly that health reform would be paid for with a combination of spending cuts and tax increases.

Baucus and others have made some progress through savings in Medicare, Medicaid and other programs.

On Wednesday, for instance, Vice President Biden said hospitals would reduce costs by $155 billion over 10 years. But nothing is final until that deal between the White House and business -- and a similar one reached with drugmakers last month -- is written into legislation.

And on the revenue side of the equation, there is still no apparent consensus.

This much is certain: Lawmakers must find ways to raise a lot of money.

Congress needs to come up with $320 billion in tax revenue over the next decade to pay for reform, Baucus told reporters Wednesday.

A problem is that one of the biggest revenue-raising proposals might be a no-go for a lot of Democrats and, according to polls, many Americans as well.

At issue is a proposal to scale back the tax break that workers get when their employers help pay for their insurance. Currently, that money is treated as tax-free income to workers. The cost to federal coffers is roughly $260 billion a year.

Taxing individuals on some part of that money could raise tens of billions a year or more.

The proposal is supported by many tax and health policy experts who say the current tax-free treatment contributes to runaway costs. The theory: Workers don't know how much their health benefits really cost because they only pay a portion of the bill. So they are more likely to consume health services they don't really need. Over time, that drives up health costs.

Senate Budget Committee Chairman Kent Conrad, D-N.D., said the idea of taxing health benefits isn't dead. But the proposal could end up being so greatly modified that it would raise far less revenue than originally hoped.

"We are searching for options, and there are a fair number of them that can work," he said Tuesday.

Perhaps, but just as with taxing health benefits, they're almost all bound to be unpopular with one group or another.

In the end, lawmakers may have to be more aggressive about cost containment or finding other revenue raisers, said Linda Blumberg, a senior fellow at the Health Policy Center of the Urban Institute.

"If you take something off the table, you've got to find something to fill the hole," she said, adding that since no option will be universally popular, lawmakers will have to be willing to make tradeoffs.

For instance, she suggested, they could boost sin taxes -- taxing alcohol and cigarettes, as well as sugary drinks, the latter of which has some support in the House but less in the Senate.

Critics say sin taxes would disproportionately tax low- and middle-income families. But Blumberg noted that they are the same groups that would benefit a lot from health reform. "They'll come out ahead with what they're getting versus what they're paying," she said.

Another possibility might be raising everyone's income tax rates by, say, 1%, Blumberg said.

Or lawmakers could opt to impose a substantive "pay or play" rule on employers. Such a mandate would require them to provide insurance for their workers or pay into a national insurance exchange to help subsidize their workers' coverage. Several proposals are under consideration -- but like the temperature of the porridge in "Goldilocks and the Three Bears," some are said to be too lenient and others too onerous on employers.

A potentially substantial revenue raiser would be to subject all income -- not just earned income, but also capital gains, dividends and other unearned income -- to the 1.45% Medicare tax paid by individuals. The progressive nonprofit group Citizens for Tax Justice estimates that kind of move -- together with increasing the Medicare tax rate to 2.5% for income over $200,000 ($250,000 for joint filers) -- could raise $500 billion over 10 years.

In a paper exploring different pay-for options, the Senate Finance Committee included expanding the Medicare tax in some ways but not nearly as broadly as applying to all unearned income.

Another idea under discussion on Capitol Hill: Charge an extra income tax known as a surtax on high-income taxpayers.

Lawmakers may also have to reconsider a proposal from President Obama to limit itemized deductions for high-income taxpayers. Neither Democrats nor Republicans liked the idea initially, asserting that it could harm charitable contributions, even though an analysis by the Tax Policy Center suggested the effect would be minimal. The Congressional Budget Office estimated the provision could raise $300 billion over 10 years.

Given how sensitive lawmakers were on the issue of the charitable contributions, however, they could exclude them from the new rule, Blumberg said. But mortgage interest and other popular itemized deductions would still be subject to the limit.

Whatever pay-for options rise to the top for consideration, they'll all face the same litmus test: Who in particular will have to pony up?

Answering that question will cause its own round of skirmishes. The debate is taking place in a very partisan environment, and one in which regional divisions between lawmakers also play a part. Since health care costs vary greatly across the country, paying for reform may disproportionately affect some states more than others. And all that adds up to a very long, hot summer ahead for those on the Hill.

- CNN Congressional producers Ted Barrett and Deirdre Walsh contributed to this report.

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