So it’s no surprise to see Republican presidential candidate Donald Trump angling for tax elimination as a possible enticement for voters this summer.
Reducing or eliminating taxes on benefits enjoys bipartisan support in Congress, and Democrats have also proposed variations on the idea. But unlike Trump, he has proposed a way to pay for the tax cuts, which would cost Social Security and Medicare $1.5 trillion over the coming decade.
Social Security has faced solvency problems. The latest estimates from the trustees who oversee Social Security show that the combined pension and disability trust funds will run out by 2035. At that time, the program will bring in enough money to pay only 83% of the benefits promised to current and future recipients. This would equate to a 17% profit cut across the board.
Revenue from the tax on benefits helps fund Social Security and Medicare Part A (hospitals); eliminating unpaid taxes would shorten Social Security insolvency by two years (to 2033), and by six years for Medicare Part A trust funds (to 2030 instead of 2037), according to the Tax Foundation.
Preventing trust fund exhaustion is a task during Social Security reform. A report by the Urban Institute found that allowing trust funds to dry up would increase the number of beneficiaries living in poverty by more than 50%, with a disproportionate impact on people of color. Meanwhile, scrapping the benefits tax would only help middle- and higher-income parents, because of the way the tax is structured. METHOD OF TAXATION
Social Security benefits were first taxed in 1984 as part of a comprehensive Social Security reform package signed into law the year before to stabilize the program’s finances. The most important part of the reform is the gradual lifting of the full retirement age to 67 from 65. But the tax collected for benefits has a supporting role, because the tax levied is credited to the Social and Medicare trust funds. In the case of Social Security, the tax is currently about 4% of the trust fund’s revenue. The tax uses a complex and unique formula that initially only affected beneficiaries with higher incomes. But the tax was created slowly so that it affected more people. Social Security benefits are indexed for wage growth and adjusted for inflation, but the income threshold level used to determine the taxable amount of Social Security benefits is not indexed for wage growth or inflation.
Here’s how it works. First, you determine a number called Social Security combined income (also sometimes called temporary income). This amount is equal to your modified gross income (MAGI) plus non-exempt interest plus 50% of your Social Security benefits. For most taxpayers, MAGI consists of all of your adjusted gross income except for the taxable portion of Social Security benefits.
No tax is paid by beneficiaries with combined income equal to or below $25,000 for single filers and $32,000 for joint filers. Beneficiaries at the next level of income – between $25,000 and $34,000 for single filers and between $32,000 and $44,000 for married couples filing jointly – pay taxes up to 50% of their benefits. Beneficiaries with income above that level pay tax up to 85% of the benefit.
Taxing Social Security income is consistent with the tax treatment of other types of retirement income, including pensions and 401 (k) accounts – the participant’s tax liability is suspended until the actual income is received.
But that doesn’t discount the affected retirees – who may be “higher earners” for income tax bracket purposes, but aren’t wealthy by real-world standards. “You can explain the policy to people, but it’s one of the things that people don’t like,” said Nancy Altman, president of Social Security Works, a progressive advocacy group.
Confounding matters, states are all over the map when it comes to taxing retirement income. Many also exempt or limit the taxation of pensions.
Only eight countries tax Social Security income. In particular, Minnesota Governor Tim Walz, who is now the running mate of Democratic presidential candidate Kamala Harris, signed legislation last year that exempts most pensioners from taxes.
At the federal level, the repeal or limitation of the taxation of Social Security benefits must be linked to a broader reform package that restores solvency and expands benefits. For example, Social Security 2100, a bill in Congress sponsored by Representative John Larson, includes a 2% benefit increase, a lower annual cost-of-living adjustment, and various targeted increases. lower-income seniors.
It would also allow Social Security to continue paying full benefits for an additional 32 years, according to an analysis by the program’s actuary. The bill pays for all of that by imposing a federal payroll tax on earnings over $400,000 and adding a new tax on investment income for high-income taxpayers.
But the law also exempts other beneficiaries from paying taxes on their benefits by creating a single set of thresholds ($35,000 and $50,000 for single and joint filers, respectively), for taxing up to 85% of the benefits, through 2034; starting in 2035, the tax threshold will return to its current level.
The bottom line: if we’re going to cut taxes for higher-income seniors, those changes must be coupled with other Social Security reforms that provide assistance across the board.
