July 9 (Bloomberg) -- The Senate Finance Committee is discussing whether to apply Medicare taxes to capital gains and other non-wage income to help pay for an overhaul of the U.S. health-care system, two people familiar with the talks said.

The move would potentially raise hundreds of billions of dollars in revenue over the next decade by boosting taxes by 1.45 percentage points on income from dividends, interest, partnerships and rentals, the people said. Dividends and long- term capital gains are now taxed at 15 percent.

The proposal, modeled after a plan released this week by Citizens for Tax Justice, would force people living off investments to contribute taxes to the health-care system, said Steve Wamhoff, legislative director for the Washington research group. It was raised yesterday in a closed-door meeting of Finance Committee Democrats, according to people in the room.

“If the only income Paris Hilton gets is capital gains, stock dividends, interest and other types of investment income, currently she is completely exempt from the one big tax we have right now that is dedicated to health care,” Wamhoff said. “We’re saying that probably doesn’t make sense.”

Medicare taxes are now assessed only on wages and self- employment income.

Senate and House lawmakers are struggling to find ways to finance the $1 trillion health-care overhaul, President Barack Obama’s top domestic priority.

Baucus Under Fire

Finance Committee Chairman Max Baucus has come under pressure from Democratic Party leaders to find alternatives to his plan to tax the costliest employer-provided health benefits, one of the most contentious issues because it is opposed by Democratic-leaning labor unions.

Senator Kent Conrad, a North Dakota Democrat and member of the finance panel, said proposals such as imposing a surtax on incomes of more than $250,000 are also under consideration, as they are in the House of Representatives.

Meanwhile, a group of self-proclaimed fiscally conservative Democrats known as the “Blue Dogs” raised “strong reservations” about a draft of legislation being considered in the House of Representatives, saying it doesn’t reduce costs enough within the system.

“We cannot simply ‘add’ new consumers to a broken system,” 40 members of the group wrote in a letter to House Speaker Nancy Pelosi of California and Majority Leader Steny Hoyer of Maryland.

The Blue Dogs also urged caution in setting new requirements for small-business owners to participate in the system. They said hospitals and doctors should be paid market rates in any government-sponsored system; reforms must benefit rural areas; and Republican support should be sought.

Taxing Higher Earners

On the Medicare tax, Citizens for Tax Justice proposed subjecting all forms of income to the 1.45 percent levy, and increasing the rate to 2.5 percent for Americans who earn more than $200,000 a year, while exempting most senior citizens’ investment income. The proposal would raise $500 billion over 10 years, Wamhoff said.

According to people in the Senate meeting, lawmakers are discussing a more modest proposal. One tack would be to add the Medicare tax only to investment income. For most capital gains and dividends, that would push the maximum tax rate to 16.45 percent. Interest and capital gains for assets owned for less than a year would face rates as high as 36.45 percent.

Another proposal would be to tax other forms of “earned” income currently exempt from the levy, such as proceeds from partnerships and rental property, according to the people. That income also faces a new top rate as high as 36.45 percent.

Lawmakers discussed applying the tax only to higher-income earners, one of the people said. Applying the Medicare tax to investment income earned by people who make more than $106,000 would generate almost $100 billion in revenue over a decade, the person cited one estimate as saying.

To contact the reporter on this story: Ryan J. Donmoyer at rdonmoyer@bloomberg.net

Last Updated: July 9, 2009 20:45 EDT