Readers are in some ways the best source of information on Social Security, so I encourage you to send feedback to me. For example, a reader recently shared a piece on legislation by Rep. Thomas Massie, R-Ky., that would repeal the taxation of Social Security benefits.
That reader is understandably upset with the current rules, which border on the bizarre.
These rules were intended to levy fees on people with "substantial outside income." Today these taxes hit people slightly above poverty with marginal tax rates that are among the highest in the entire tax code.
The e-mail continued to suggest that these levies represent double taxation, and he is correct. A pension restructures your paycheck from today to the future. It is taxed in the year that it is earned, and again when it is collected. This tax policy is no different from taxing someone who gets change for a $20 bill by calling the 10 and pair of fives income.
The Writer Couldn’t Be More Right
The writer even understated the case. These rules discourage retirees from preparing for retirement. This means that these rules have turned a program designed to alleviate poverty-ridden old-age into one that incentives it.
If the words "tax reform" meant anything, these rules would be among the first to be re-written. They are not only unfair but also horribly complex ensuring to ensnare any senior who has better things to do with his time than read IRS tax code.
Reform Isn’t Going to Happen
While I suspect that few rules in the entire tax code are as egregiously broken, change is not possible. The Massie legislation is a fair starting point to illustrate why. At this point, the revenue generated by the taxation of Social Security benefits is returned to the various social insurance programs. Rep. Massie believes that the federal government should repeal this tax, and replace this revenue stream with pennies from heaven.
Massie said that the legislation would direct the Treasury Department to compensate the program "equal to the reduction" created by the reduced tax overhaul. He also indicated that this spending cannot be offset with tax increases.
While the rules aren’t fair, this revenue is vital to the system. It is growing at a staggering pace, more than doubling over the next 10 years to more than $80 billion, a sum that approximates the revenue generated by 20 million workers. The difference is however that this revenue is free cash flow, where as actual farm hands generate the cost of future benefits.
The growth in revenue comes from two factors. First, the formula for triggering the tax is not indexed to inflation. If it were adjusted for buying power, the tax would start around $60,000 rather than $25,000. Second, the use of deferred tax accounts, 401Ks for example, makes seniors appear to have wage income later in life. Thus, the Treasury is collecting tax on greater amounts of income from a growing audience.
It is simply not possible to confuse this revenue source with publically issued debt that pays hard interest.
How Does This Approach Play Out
As a result of this proposal, Sen. Bernie Sanders, I-Vt. for example, would get to keep nearly $20,000 because he no longer faces a tax on his $50,000 of annual Social Security benefits. In exchange, the future tax payers of the nation would get an additional bond to offset the largess kept by the Senator and his wife.
Every year the government would write larger and larger checks. In 10 years, the work force would continue to pay the 12.4 percent wage tax. On top of that, the government would kick in nearly $100 billion to the program in hard subsidies. But the combined amount isn’t even enough to ensure Sen. Sanders keeps his full benefit check. So the government would spend more than $300 billion to buy back the debt held by the Social Security Trust Fund.
What could possibly go wrong with that plan?
This isn’t the intended outcome of course, but the fact is that some wealthier seniors do lose a large portion of their benefits. As a consequence, ending this tax would primarily serve wealthier seniors at the expense of either future seniors or future tax payers. No one is entirely sure of which.
While this tax is unfair, and not well thought-out, the replacement tax is even less fair and less considered. These subsidies will come from people who aren’t even eligible to collect benefits. The fabled workers of Galveston County, Texas for example do not participate in Social Security. In this case, Rep. Massie seeks to levy taxes on these people who abandoned Social Security decades ago. It should be impossible to believe that these people will not expect benefits in return.
How Did We Get Here?
In 1983, Social Security had a financial problem, one that Congress addressed by creating a fairness problem. Even back then, everyone knew that the taxation of benefits meant that the nation would claw back benefits from people in poverty.
The fairness problem isn’t a surprise. The taxation of benefits aspect of the reform was the single largest savings in the entire reform package, providing about one-third of the overall solution. At the time of the original legislation, these rules affected something close to 3 percent of beneficiaries. In 2012, 70 percent of tax returns including Social Security benefits generated a tax.
Kicking the Can Down the Road
We solved the financial problem of 1983 with a fairness problem that grows into eternity. Congress intended to pass the buck from then-retirees to future retirees. Not surprisingly, that approach is unpopular with current retirees who want Congress to pass that same buck to someone else.
In short, the proposal seeks to repeat the 1983 solution. It would solve the fairness problem by making the financial problem even worse.
Brenton Smith writes on all aspects of Social Security reform, translating the numbers and jargon of the issue into terms that everyone can understand. His work has appeared in Forbes, MarketWatch, Fox Business, The Hill, and a number of regional newspapers. To read more of his reports — Click Here Now.
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