RE: Taxing Benefits

[National Dialogue Moderator <moderator>]

Taxing Social Security benefits like other pension income makes sense. It 
is a way to bring additional revenue into the system in an equitable 
manner. Current law exempts income below a certain threshold from taxation 
but most low income elderly don't have much if any tax liability generally 
so removing these thresholds would simplify things without harming low 
income beneficiaries.

Beyond removing the thresholds there is the question of how much of the 
benefit to tax. It is not as straightforward as you might think. There are 
several models you can look at. Should it be taxed like a contributory 
defined benefit plan? Under that theory, you keep track of contributions 
made by an individual. That amount is not subject to tax but all amounts in 
excess of that are subject to income tax. Should employer contributions on 
behalf of an individual be exempt as well? They were deducted by the 
employer already, so theoretically no. The current law tax of 85% of 
benefits is a proxy for this approach. 

Another theory says that half the contributions were after-tax (the 
employee share) and half were already deducted (the employer share) so 50% 
of the benefits should be taxed (the old rule). This obviously brings in 
less money.

But what happens when you go to the "tax everything in excess of 
contributions model"? Low income beneficiaries are still exempt because of 
other tax subsidies, exemptions, etc. Middle income beneficiaries tax 
burden increases, largely because the thresholds are removed. And, 
surprise! Many upper income beneficiaries would actually owe less in tax on 
their benefits because their contributions represent such a large 
percentage of their ultimate benefit. (Their "basis" is huge for you tax 
aficionados.) If folks figure this out the political viability of this 
approach will plummet and we may end up removing the thresholds but keeping 
the 85% proxy which would result in higher taxes for middle and upper 
income beneficiaries. This would be an equitable result.

Ann Combs
William M. Mercer