Social Security: Taxation of Benefits

Publication Date: September 2003

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

Until 1984, Social Security was exempt from the federal income tax. For years many analysts advocated that it be treated like other pensions, whose benefits are fully taxable except for the portion attributable to the worker's contributions. To help restore the program's solvency, in 1983 Congress made up to 50% of benefits taxable for taxpayers whose income plus 50% of their benefit exceeds $25,000 for individuals or $32,000 for couples. The proceeds are credited to the Social Security trust funds. In 1993, President Clinton proposed that up to 85% of Social Security benefits be taxable (the proportion said to be the least anyone would pay under the rules applying to other pensions). The 1993 omnibus budget reconciliation bill (P.L. 103-66) limited the measure to recipients whose threshold incomes exceed $34,000 (single) or $44,000 (couples), with proceeds from this measure going to Medicare.

Repeal of the 1993 provision was part of the Republican "Contract with America," and was approved by the House of Representatives as part of the omnibus budget reconciliation bill (H.R. 2491) but was not included in the final law. Subsequently, with Social Security again facing long-range financing problems, proposals have been made to increase taxation of benefits further. The 1994-1996 Advisory Council on Social Security recommended that taxation of benefits should be increased, as did two bills in the 105th and 106th Congresses. There also continues to be pressure to repeal or mitigate the effects of the taxation of Social Security benefits. In the 106th Congress, 15 bills were introduced that would reduce taxes on benefits. In 2000, the House approved H.R. 4865, which would have repealed the 1993 provision, thus lowering the maximum amount of benefits subject to taxation from 85% to 50%, and would have replaced the resulting reduction in revenue to Medicare with general fund transfers. In the 107th and 108th Congresses, 12 and 14 bills, respectively, have been introduced that would liberalize the taxation provision.

Proponents of repeal argue that taxation of benefits is unfair, as it changed the rules in the middle of the game, penalizing recipients who relied on old law and who cannot change past work and savings decisions. Regardless of abstract arguments about tax principles, many recipients regard increased taxation as simply a reduction in the benefits they had been promised. They see taxation of benefits as an indirect means test, which they oppose because they view Social Security as an "earned right," unlike welfare, where need determines the level of benefits. Finally, they maintain that it grossly distorts marginal tax rates and provides a strong disincentive for many recipients to work.

Opponents of repeal argue that it would be a giveaway for well-off recipients that would weaken the Social Security and Medicare trust funds. It would enlarge an inequitable tax advantage for Social Security benefits, especially when the aftertax income of recipients is compared to that of working families with the same gross income. Moreover, they say that if benefits must be cut to restore solvency to Social Security and Medicare, taxing benefits is the most equitable and efficient way to implement de facto benefit reductions. They say that taxing benefits concentrates more of the burden on higher income households, and thus better aligns benefits with need, than would broader measures that would also affect poorer recipients.