Social Security: Taxation of Benefits

Social Security: Taxation of Benefits

Order Code RL30581
CRS Report for Congress
Received through the CRS Web
Social Security: Taxation of Benefits
Updated September 9, 2003
Geoffrey Kollmann
Specialist in Social Legislation
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

Social Security: Taxation of Benefits
Summary
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 In 2000, the House approved H.R. 4865, which would have repealed the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 after-
tax 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.

Contents
Current Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Effect on Recipients and Trust Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
P.L. 103-66 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Treatment of Nonresident Aliens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Proposed Changes in Taxation of Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Contract with America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Recent Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Legislation in the 107th Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Legislation in the 108th Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Arguments for Taxation of Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
The Financial Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Tax Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Alignment of Benefits with Need . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Arguments Against Taxation of Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Deliberalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Special Nature of Social Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Effect on Marginal Tax Rates and Incentives to Work . . . . . . . . . . . . . . . . 13
List of Figures
Figure 1. Total Federal Tax Burden Under Current Law . . . . . . . . . . . . . . . . . . 11
Figure 2. Marginal Tax Rates on Additional Income . . . . . . . . . . . . . . . . . . . . . 14
List of Tables
Table 1. Effect of Taxing Social Security Benefits Under Current Law by Income
Class, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2. Additional Federal Income Tax Liability in 2003
Under P.L. 103-66 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Social Security: Taxation of Benefits
Current Law
In general, the Social Security and tier one Railroad Retirement (analogous to
Social Security) benefits of most recipients are not subject to the income tax.
However, up to 85% of Social Security and tier one Railroad Retirement benefits can
be included in taxable income for recipients whose “provisional income” exceeds
certain thresholds.
“Provisional income” is adjusted gross income, but modified to include
otherwise tax-exempt “interest” income (i.e., interest from tax-exempt bonds), plus
one-half the Social Security benefit. The thresholds below which no Social Security
or tier one benefits are taxable are $25,000 (single), $32,000 (couple filing joint
return) and $0 (couple filing separately).
The tax on benefits when provisional income exceeds these thresholds depends
on the level of the provisional income. If it is between the $25,000 or $32,000
threshold and a second level threshold of $34,000 (single) or $44,000 (couple), the
amount of benefits subject to tax is the lesser of: (1) 50% of benefits; or (2) 50% of
income in excess of the first threshold. If income is above the second threshold, the
amount of benefits subject to tax is the lesser of:
(1) 85% of benefits; or
(2) 85% of income above the second threshold, plus the smaller of:
(a) $4,500 (single) or $6,000 (couple); or
(b) 50% of benefits.
For couples filing separately, taxable benefits are the lesser of 85% of benefits
or 85% of provisional income.
Neither the first nor second level thresholds are indexed to rise with inflation or
wage growth.
This tax treatment differs from that of private and public pension benefits, in
which all benefits that exceed the nominal amount (i.e., actual dollars unadjusted for
inflation or interest) of the employee’s contribution are fully taxable.
It was
projected that about 32% of Social Security recipients paid income tax on their
benefits in 2000.
The proceeds from taxation of Social Security and tier one benefits at the 50%
rate are credited to the Social Security trust funds and the Railroad Retirement

CRS-2
system, respectively. Proceeds from taxation of Social Security benefits and tier one
benefits at the 85% rate are credited to the Hospital Insurance trust fund of Medicare.
Example 1 below illustrates how the provision currently works. The taxable
portion of a $10,000 annual benefit for a single taxpayer who has $32,000 in adjusted
gross income is computed thus: First, provisional income is determined (½ x
$10,000 = $5,000 [one-half of the Social Security benefit], + $32,000 [adjusted gross
income] = $37,000). Because this amount is over the second-level threshold of
$34,000, 85% of the difference between provisional income and the second-level
threshold ($37,000 minus $34,000 = $3,000 x 85% = $2,550) is added to the lesser
of (a) $4,500 or (b) $5,000 (50% of benefits). In this case $2,550 + $4,500 = $7,050.
Example 1: Current Law
Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $32,000
½ of benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . +5,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,000
Less current law exempt amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -25,000
Excess . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Taxable benefits based on first threshold . . . . . . . . . . . . . . . . . . . . . . . . . . 4,500
(lower of 50% of excess,
50% of benefits, or $4,500)
85% of excess above
second threshold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,550
[$37,000 - $34,000) x 85%]
Total benefits taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,050
(taxable portions above first
and second thresholds, or
85% of benefits, if lower)
If in this example the recipient’s adjusted gross income were, say, $28,000,
provisional income would be $33,000 (one-half the Social Security benefit [$5,000]
plus $28,000 = $33,000). Because this sum is less than the applicable second level
threshold of $34,000, the amount of benefits subject to tax is the lesser of (a) 50%
of benefits ($5,000) or (b) 50% of the difference between provisional income and the
first-level threshold ($33,000 minus $25,000 = $8,000 divided by 2 = $4,000).
Because $4,000 is less than one-half of the Social Security benefit, $4,000 would be
the amount of benefits subject to the income tax. If the recipient’s other income were
less than $20,000, he would pay no tax on his Social Security benefits because the
combination of one-half of his Social Security ($5,000) and his other income would
be less than the threshold of $25,000.

CRS-3
Effect on Recipients and Trust Funds
Because of the $25,000 and $32,000 thresholds, recipients with low incomes are
largely unaffected by the taxation of benefits. Of those affected, the majority have
annual incomes of $50,000 or more. Table 1 shows, for varying levels of income,
the number and proportion of recipients who were estimated to pay taxes on their
benefits in 2000, and the amount of taxes they were projected to pay. These are
averages, and do not necessarily indicate the actual tax liability of persons in these
income brackets.
Table 1. Effect of Taxing Social Security Benefits
Under Current Law by Income Class, 2000
Number
Number of
Percent of
Aggregate
affected by
SS
recipients
amount of
Level of individual
taxation of
recipients
affected by
taxes on
or couple incomea
benefits
(in
taxation of
benefits
(in
thousands)
benefits
(in millions)
thousands)
Less than $10,000
7,157
2
0%
0
$10,000 to $15,000
4,845
7
0%
$2
$15,000 to $20,000
3,509
12
0%
$4
$20,000 to $25,000
3,439
22
1%
$14
$25,000 to $30,000
2,854
360
13%
$48
$30,000 to $40,000
5,225
2,237
43%
$650
$40,000 to $50,000
3,918
3,598
92%
$1,948
$50,000 to $100,000
6,705
6,608
99%
$9,424
$100,000 and more
2,737
2,723
100%
$7,386
All
40,390
15,569
39%
$19,476
Source: Congressional Budget Office, based on the Current Population Survey (CPS).
Note: Aggregate benefits, recipients and revenues are understated by about 10% because of benefits
paid abroad, deaths of recipients before March interview, and exclusion of institutionalized recipients.
a Cash income (based on income, including Social Security, of tax filing unit), plus capital gains
realizations.
History
Until 1984, Social Security benefits were exempt from the federal income tax.
The exclusion was based on rulings made in 1938 and 1941 by the Internal Revenue
Service (IRS). The reasoning then appeared to be that: (1) the lack of an explicit

CRS-4
provision to tax benefits implied that Congress did not intend for them to be taxed;
(2) the benefits were intended to be “gifts” made in aid of the general welfare, not
annuities; and (3) taxing benefits would defeat the underlying purposes of the Social
Security Act.
Under these rules, the treatment of Social Security was similar to that of some
types of government transfer payments (such as Aid to Families with Dependent
Children, Supplemental Security Income, and black lung benefits), but in sharp
contrast to that of retirement benefits under private pension plans, the Federal Civil
Service Retirement System (CSRS), and other government pension systems.
Benefits from these other pension plans are fully taxable except for the proportion of
total lifetime benefits (using projected life expectancy) attributable to the employee’s
own contributions to the system (and on which he or she had already paid income
tax). Both the value of the lifetime contributions and expected benefits are computed
in nominal (i.e., current) dollars. Using nominal dollars excludes the effects of
inflation or interest, typically making a large portion of these benefits taxable (e.g.,
usually more than 90% of a CSRS benefit is fully taxable).
Under Social Security, the worker’s contribution to the system is his or her
share, or one-half, of the payroll tax, officially known as the Federal Insurance
Contributions Act (FICA) tax. The amount the worker pays into the Social Security
system is taxed as income when earned. The employer’s contributions to the system,
however, are not considered part of the employee’s gross income and are deductible
from the employer’s gross business income as a business expense. In other words,
neither the employee nor the employer pays taxes on the employer’s contribution.
Thus, under the old law the benefits resulting from the payment of payroll taxes were
not only tax free, but arose from income partially sheltered from taxation.
For years many analysts questioned the basis for the IRS rulings and advocated
that the tax treatment of Social Security be the same as for other pension income.
The 1979 quadrennial Advisory Council on Social Security debated whether Social
Security benefits should be subject to taxation. A majority concluded that the
original IRS ruling was wrong and that the tax treatment of private pensions was a
more appropriate model for tax treatment of Social Security. They estimated that the
most anyone who entered the workforce in 1979 would pay in nominal payroll taxes
during his or her lifetime would equal 17% of the Social Security benefits he or she
would ultimately receive. (This was the most any individual would pay; in the
aggregate workers would make payroll tax payments amounting to substantially less
than 17% of their ultimate benefits.) Because of administrative difficulties involved
in determining the taxable amount of each individual benefit, the Council
recommended instead that half of everyone’s benefit be taxed. They justified this
ratio as a matter of “rough justice” and noted that it coincided with the portion of the
tax (the employer’s share) on which income taxes had not been paid.
However, it was only after the Social Security system was threatened with
insolvency in the early 1980s that taxing benefits received serious political attention.
The 1982 National Commission on Social Security Reform proposed that, beginning
in 1984, one-half of Social Security cash benefits and tier I benefits payable under the
Railroad Retirement Act be taxable for individuals whose adjusted gross income,
excluding Social Security cash benefits, exceeded certain thresholds, with the

CRS-5
proceeds of such taxation credited to the Social Security trust funds.
The
Commission deliberately did not include any provisions for indexing the threshold
amounts. It was understood that as nominal incomes rise, as they nearly always have,
increasing proportions of Social Security recipients would be affected by the
proposal. The Commission’s proposal had an obvious “notch” problem, in that the
extra dollar of income that would put one over the threshold would have had the
effect of subjecting fully one-half of Social Security benefits to taxation. In enacting
the 1983 Social Security Amendments (P.L. 98-21), Congress essentially adopted the
Commission’s recommendation, but substituted an arrangement for determining the
amount of benefits to be taxed that imposed the tax on benefits gradually as a
person’s income rose above the thresholds. Under this arrangement, the amount of
taxable benefits was the lesser of one-half of benefits or one-half of the excess of the
taxpayer’s provisional income (see above) over thresholds of $25,000 (single) and
$32,000 (couple).
In subsequent years, pressure to solve the government’s mounting fiscal
problems led to calls to subject a greater share of benefits to taxation. Many
supporters of doing so maintained that Social Security should be treated like private
and public pensions. In 1990, the Social Security Administration’s Office of the
Actuary determined that, if these pension tax rules were applied to Social Security,
the ratio of total employee Social Security payroll taxes to expected benefits (all in
nominal dollars) for current recipients would be, on average, about 4% or 5%. For
workers entering the workforce today and for the next decade, the ratio would be, on
average, about 7%. Because Social Security benefits replace a higher proportion of
earnings of workers who are lower paid and have dependents, and because women
have longer life expectancies, the workers with the highest ratio of taxes to benefits
would be single, high-paid males. The ratio for these workers entering the workforce
today would be 15%.
Strict application of the tax rules for private and public pensions was seen to
present practical administrative problems, however.
Determining the proper
exclusion would be complex; for example, it is possible that several people may
receive benefits based on the same worker’s account. It was recognized that a
simpler and more practical approach would be to approximate the effect of applying
private pension rules by subjecting a set percentage of Social Security benefits to the
income tax. Taxing 85% of benefits (the portion of benefits on which tax would not
have been paid for single, high-paid males) was suggested because it would ensure
that no one would have a higher percentage of benefits subject to tax than if the tax
policy for private and civil service pensions were actually applied. It also would
ensure that no one was taxed twice on the same income (i.e., no “double taxation”).
P.L. 103-66
As part of his plan to cut the federal budget deficit, President Clinton proposed
on February 17, 1993, that the proportion of benefits subject to taxation should be
increased from 50% to 85%, effective in 1994. His budget document said this would
“move the treatment of Social Security and Railroad Retirement tier I benefits toward
that of private pensions.” Just as under then current law, only Social Security
recipients whose provisional income (modified adjusted gross income plus one-half
of their benefits) exceeded the thresholds of $25,000 (single) and $32,000 (couples)

CRS-6
were to pay tax on their benefits. Also as under current law, the first step was to add
one-half (not 85%) of benefits to adjusted gross income. However, 85% of the
difference between the resulting figure and the thresholds was to be compared to 85%
of the Social Security benefits, and the lesser of the two figures was to be the amount
of benefits taxed. Structured this way, the measure was meant not to affect recipients
currently exempt from paying taxes on benefits.
The proposal was included in President Clinton’s FY1994 budget. The proceeds
would not have been credited to the Social Security trust funds, as under then current
law, but to the Medicare Hospital Insurance program, which has a less favorable
financial outlook than does Social Security.
Doing so also avoided possible
procedural obstacles (budget points of order that can be raised regarding changes to
the Social Security program in the budget reconciliation process). This measure was
included in the 1993 Omnibus Budget Reconciliation Act (OBRA) passed by the
House on May 27, 1993.
The Senate version of the bill adopted the 85% measure, but imposed it only
after an individual’s or couple’s AGI plus one-half of Social Security exceeded new
thresholds of $32,000 and $40,000. When the House and Senate versions of the
budget package were negotiated in conference, the conferees modified the Senate
taxation of Social Security benefits provision by setting the second level thresholds
at $34,000 (single) and $44,000 (couple). At that time, the proposal was projected
by the Joint Committee on Taxation to produce revenues of $24.6 billion to the HI
trust fund over 5 years, and affect about 13% (about 5 million) Social Security
recipients.1 On August 6, 1993, the Senate passed the bill by a vote of 51-50.
President Clinton signed the measure into law (as part of P.L. 103-66) on August 10,
1993. Table 2 shows examples of the additional tax liability of recipients in 2003
under P.L. 103-66.
Table 2 also can be used to illustrate the reduction in tax liability that would
occur if the 1993 provision were repealed, effective in 2003.
1 In 2003, the Congressional Budget Office estimates that about 23% of Social Security
recipients (almost 11 million people) are now affected by the 1993 provision, i.e., pay at
least part of the tax on their Social Security benefits at the 85% level.

CRS-7
Table 2. Additional Federal Income Tax Liability in 2003
Under P.L. 103-66
Annual Social Security benefits
$5,000
$10,000
$15,000
$20,000
$25,000
Other incomea
Additional tax liabilityb
Single Filers
c
d
$20,000
—
—
—
c
d
$25,000
—
—
—
c
d
$30,000
—
$52.50
$198.75
c
d
$35,000
$472.50
$945.00
$1,140.75
c
d
$40,000
$472.50
$945.00
$1,417.50
c
d
$50,000
$472.50
$945.00
$1,417.50
c
d
$75,000
$517.50
$1,050.00
$1,575.00
c
d
$100,000
$525.00
$1,050.00
$1,575.00
Joint filerse
$20,000
—
—
—
—
—
$25,000
—
—
—
—
—
$30,000
—
—
—
—
—
$35,000
—
—
—
$52.50
$183.75
$40,000
—
$127.50
$221.25
$315.00
$446.25
$50,000
$262.50
$525.00
$787.50
$1,482.00
$2,254.50
$75,000
$472.50
$945.00
$1,417.50
$1,890.00
$2,362.50
$100,000
$472.50
$945.00
$1,417.50
$1,890.00
$2,362.50
a Adjusted gross income excluding Social Security, and assuming no tax-free interest is received.
b Individuals are assumed to be age 65 or older and use the standard deduction. Illustrations do not
show the effect of the tax cuts enacted later in the year.
c Very few single individuals currently receive this level of benefits.
d Virtually no single individual currently receives this level of benefits.
e Does not include those who might choose to file separately.
Because the new law incorporated both old and new rules, the computation of
total taxable benefits can be complicated. (For a detailed explanation of how the
taxable portion of benefits is computed, see archived CRS Report 93-336,
Determination of Taxable Social Security Benefits Under New Law: A Fact Sheet,
by Geoffrey Kollmann.)

CRS-8
Treatment of Nonresident Aliens
Citizenship is not required for receipt of Social Security benefits. Aliens may
receive benefits provided they have engaged in covered employment and otherwise
meet eligibility requirements. However, aliens residing outside the United States are
subject to different tax withholding rules. Because the U.S. Government does not
know the amount of other income of these individuals on which to base a tax rate,
Section 871 of the Internal Revenue Code imposes an arbitrary rate of tax
withholding (30%) on almost all the U.S. income of nonresident aliens, unless a
lower rate is fixed by treaty. Thus, 30% of 85% of a nonresident alien’s Social
Security is subject to income tax withholding (i.e., the thresholds do not apply).
Proposed Changes in Taxation of Benefits
Contract with America
During the 1994 Congressional campaign, Republican leaders pledged that if
they gained control of the House of Representatives they would enact certain
measures contained in a “Contract with America.” One such measure promised to
repeal the OBRA 1993 provision over a period of 5 years. For nonresident aliens, the
percentage of benefits subject to income tax withholding would likewise drop
gradually to 50%. The measure was included in the version of the 1995 omnibus
budget reconciliation bill (H.R. 2491) approved by the House, but not in the Senate
version, and was not included in the conference agreement or final bill.
Recent Proposals
Subsequently, with Social Security again facing long-range financing problems,
proposals have been made to increase taxation of benefits further. Although the
1994-1996 Advisory Council on Social Security could not agree on a common
solution to Social Security’s long-range financing problems, splitting into three
factions, it did recommend that the income thresholds be eliminated, and two of the
factions also recommended that all benefits in excess of contributions be taxable.
Bills to restore solvency to the system introduced by Senator Moynihan (S. 1792 in
the 105th, and S. 21 in the 106th, Congress) also proposed full taxation of benefits.
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 liberalize the taxation provision. On July 13, 2000, during consideration
of H.R. 8, the Death Tax Elimination Act, the Senate adopted (58-41) an amendment
by Senator Grams that would have repealed the 1993 provision effective in 2001.
However, this amendment was later dropped in order to make the Senate version of
the bill identical to the House version.
On July 19, 2000, the Committee on Ways and Means approved H.R. 4865, a
bill that, effective in 2001, would have repealed the 1993 provision, thus restoring
the maximum amount of benefits subject to taxation to 50%, by a vote of 22-15. For
nonresident aliens, the percentage of benefits subject to income tax withholding

CRS-9
likewise would drop gradually to 50%. Preliminary estimates were that about 20%
(about 9 million) of Social Security recipients would have been affected by the bill.
The loss of revenue to the Medicare trust funds this would produce was estimated to
be $44.6 billion over 5 years. To compensate, the bill provided that an amount equal
to what the 1993 provision would have generated would be calculated by the
Treasury Department and such amount would be credited to the HI trust fund through
a permanent appropriation from the general fund. On July 27, 2000, the House
approved H.R. 4865 by a vote of 265 to 159. A Democratic alternative, which would
have raised the thresholds at which the 85% taxation applies to $80,000 (single) and
$100,000 (couple), with the general fund reimbursing the HI trust fund for the
resulting foregone revenue, was rejected by a vote of 169-256. The tax reductions
in this proposal would have applied only in years when the non-Social Security and
Medicare surplus (i.e., the budget surplus excluding Social Security and Medicare),
was adequate to cover the general fund reimbursement of the HI trust fund.
Legislation in the 107th Congress. In the 107th Congress, 12 bills were
introduced that would have altered the taxation of Social Security benefits. Seven
(H.R. 122, H.R. 192, H.R. 1018, H.R. 2548, H.R. 4789, H.R. 5568, and S. 237)
would have repealed the 1993 provision, returning the maximum amount that can be
subject to taxation to 50% of benefits. Three, H.R. 1532, H.R. 4790, and S. 181,
would have also repealed the 1983 provision, and thus would have restored the
original tax-free status of Social Security benefits. H.R. 2106 would have increased
the thresholds at which up to 85% of the benefit begins to be taxed by raising them
to $80,000 and $100,000, respectively. H.R. 209 would have excluded income from
municipal bonds from the computation of how much of the benefit is taxable.
Legislation in the 108th Congress. In the 108th Congress, 14 bills have
been introduced that would alter the taxation of Social Security benefits. H.R. 133,
(King), H.R. 378, (Musgrave), H.R. 423, (Paul), H.R. 434, (Sam Johnson), H.R. 860
(Toomey), H.R 2439 (Weldon), S. 514 (Bunning), and S. 767 (Gordon Smith) would
repeal the 1993 provision, returning the maximum amount that can be subject to
taxation to 50% of benefits. H.R. 424 (Paul), H.R. 1897 (Weiner), H.R. 2346 (T.
Franks) and S. 1026 (Shelby) would exempt all Social Security benefits from the
income tax. H.R. 202 (Rep. Stupak), would provide an annual adjustment to the
$25,000, $32,000, $34,000 and $44,000 thresholds so that they would rise in
proportion to inflation. H.R. 2072 (M. Foley), would “eliminate the marriage
penalty” by raising the thresholds for married couples from $32,000 and $44,000 to
$50,000 and $68,000, respectively (i.e., it would make the thresholds for couples
exactly twice those of single individuals). Although it would not affect the taxation
of Social Security benefits, S. 397 by Sen. Ensign would make the Social Security
payroll taxes workers pay tax deductible. One result of doing so would be to mitigate
the argument that taxation of benefits is “double taxation.”
On March 25, 2003, during consideration of tax-cutting measures in the FY2004
budget resolution, the Senate rejected by a vote of 51 - 48 an amendment by Senator
Bunning that would have increased tax cuts by $146 billion over ten years to make
room for repeal of the 1993 taxation of benefits provision.

CRS-10
Arguments for Taxation of Benefits
The Financial Perspective
Those who oppose full or partial repeal of taxation of benefits refer to the large
loss of income that this would impose on Social Security and Medicare. They point
out that it was the projected loss to Medicare of $46 billion over 10 years that led the
Senate and conferees to reject the House measure in the 1995 OBRA bill. The 2003
report of the HI Board of Trustees projects that the HI trust fund will become
insolvent in 2026. The loss of the revenue — $53 billion in the next 5 years, $151
billion in the next 10 years — that would be caused by repealing the 1993 OBRA
provision would make this problem worse. The long-range effects also would be
substantial. Over the next 25 years, it would lose revenue equal to between 0.2% and
0.3% of taxable payroll. (Taxable payroll is the amount of earnings in the economy
subject to the HI tax; it is used in long-range forecasts because projected wage and
price growth renders costs expressed in dollar terms essentially meaningless.) The
effect would be larger in subsequent years because over time larger proportions of
recipients will have income above the non-indexed thresholds. They also express
concern that replacing the income from taxing benefits with general revenue
appropriations would weaken the Medicare program. They argue that financing the
program with a dedicated tax is more reliable and buttresses the conception that
Medicare is an “earned right.” They argue that using a general revenue appropriation
weakens this link and makes the program look more like welfare. They also express
fear that the permanent loss of the revenue to the government caused by repeal of the
1993 provision, especially when combined with other recent tax cuts and spending
increases, would expand budget deficits to unsupportable heights.
In addition to the HI trust fund losses, the revenue loss to Social Security also
would be substantial if the taxation of benefits were totally repealed — $80 billion
in the next 5 years, $211 billion (not including interest) over the next 10 years. Over
the next 75 years, it would lose revenue equal to 0.7% of taxable payroll, thus
increasing Social Security’s long-range deficit by 36%.
Many supporters of benefit taxation say that, if anything, taxation should be
increased, not reduced. If Social Security benefits were taxed in the same manner as
private pensions, the long-range financing problem would be reduced by about 20%.
Tax Equity
Economic theory generally supports the idea of treating Social Security benefits
similarly to other retirement income. Because equal income, regardless of source,
theoretically represents equal ability to pay taxes, it is considered unfair to confer an
advantage on one source of income over another. From this perspective, income is
income and should be equally taxed. Thus, many adherents would go further than
merely raising the proportion of benefits that are taxable; i.e., they see no logical
reason for the income thresholds, and they point out that eliminating these thresholds
would eliminate the distortion in marginal tax rates they cause — see below. From
this point of view, exclusions from the tax base produce inequities. Besides the
instance where two individuals have the same total income but pay different taxes

CRS-11
because one has more Social Security income than the other, there is the instance
where exclusion of Social Security from progressive taxation is worth relatively more
to those who, because of other taxable income, are in higher tax brackets. Put
another way, many people think it is unacceptable that even millionaires would get
to exclude all or part of their Social Security benefits from the income tax.
In the same vein, they say it is unfair that Social Security recipients pay
substantially less tax than do current workers, especially when Social Security and
Medicare taxes under the Federal Insurance Contributions Act (FICA) are included.
Chart 1 contains illustrations that compare the total federal tax burden (income and
FICA taxes) of retired versus working couples under current law. It shows, for
example, that a retired elderly couple with an income of $30,000 ($15,000 of which
is Social Security) pays no federal taxes, whereas a working couple with $30,000 of
earnings pays $4,008. A retired elderly couple with an income of $50,000 ($15,000
of which is Social Security) pays about 35% of the federal taxes paid by a working
couple with $50,000 in earnings. Because most states do not tax Social Security and
many grant extra exclusions for pension income and additional exemptions for the
elderly, this disparity is larger when state income taxes are included. If the 1993
provision is repealed, critics say, the advantage higher-income Social Security
recipients would receive relative to workers would be even greater.
Figure 1. Total Federal Tax Burden Under Current Law
$16,000
$14,168
Re tire d Couple
$14,000
Working Couple
FIC A
$12,000
$8,618
$10,000
$7,692
$8,813
$8,000
FIC A
$6,000
$4,008
$4,793
$3,045
$4,000
FIC A
$2,000
$0
$1,793
$0
$30,000
$50,000
$70,000
Annual Income
Retired couple receives $15,000 annually in Social Security benefits. All income of
working couple is from earnings. Each couple takes the standard deduction — retired
couple takes the additional standard deduction for the elderly. Figures are for 2003.

CRS-12
Alignment of Benefits with Need
Proponents say that, if Medicare and Social Security’s long-range financing
problems are to be addressed in part by selective benefit cuts, taxation of benefits is
among the most equitable and effective ways to do so. They point out that many
advocates of reducing government spending usually try to structure their proposals
so that the poor and/or lower middle-income recipients are protected from benefit
cuts. When developing the details of how to accomplish this, they often conclude
that the income tax system is the easiest and most effective way to protect the less
well-off from loss of income.
A variation of this perspective is that benefit cuts should be concentrated on
those most able to afford them. By concentrating more of the burden on higher
income households, taxing benefits more fully aligns them better with “need” than
would broader measures that would also affect the poor (such as cutting the annual
cost-of-living-adjustment). Thus, many regard taxation of benefits as an indirect
“means test,” but without the cumbersome and intrusive administrative process a
direct means test would entail. From this point of view, taxing benefits is seen not
as a tax increase, but as a de facto reduction in benefits scaled to bear most heavily
on better-off recipients.
Arguments Against Taxation of Benefits
Deliberalization
Opponents of taxation of benefits argue that it is unfair and imposes financial
hardship because it lowers incomes of those who cannot change past work and
savings decisions. They contend that it changes the rules in the middle of the game,
with the heaviest impact on older workers and current retirees who made decisions
based on old law and who may be living in large part on their Social Security.
Regardless of abstract considerations of tax equity, many recipients regard increased
taxation as simply a reduction in the benefits they had been promised. As shown in
Table 2, the impact can be substantial. For example, today a single individual with
a $10,000 annual benefit and other income of $35,000 pays $945 more in income
taxes than he or she would had the 1993 provision not been enacted. Also, these
increases affect many middle-income people, not just the “rich.”
Special Nature of Social Security
Opponents argue that Social Security is different from other government
programs. They maintain that Social Security is unique because it is a “social
contract” across generations, in which citizens have paid into the system over their
working lives in exchange for promised benefits. They object to the argument that
taxing benefits is the best way to align benefits with need. They dislike the concept
of indirect means testing because it makes Social Security appear more like welfare,
where need determines the level of benefits. They dispute that Social Security and
private pensions are analogous, saying that they serve different purposes. They assert
that, as the country’s only national social insurance system, which provides a bedrock

CRS-13
level of protection to nearly all workers and their families from loss of income due
to the death, retirement, or disability of the worker, Social Security is special and
should be so treated. To them, the 1993 provision was simply a measure designed
specifically to reduce the budget deficit.
Effect on Marginal Tax Rates and Incentives to Work
Some critics see taxation of benefits as a benefit reduction; others see it as
merely an increased tax. As a tax increase, they say it greatly distorts marginal
income tax rates. For example, the pre-1993 provision has the effect of increasing
the marginal tax rate by at least 50% for additional income that falls between the first
level thresholds ($25,000 or $32,000) and the point at which fully one-half of
benefits is taxable. The reason is that for each dollar earned above the threshold
amount, $1.50 becomes subject to tax. Thus, on that extra dollar of income, the
effective marginal tax rate is 50% higher (e.g., 10% becomes 15%, 15% becomes
22.5%, and 27% becomes 40.5%). Under the 1993 provision, for income above the
second level thresholds the effect is to subject $1.85 to tax for each dollar earned
above the second level threshold amount (e.g., 10% becomes 18.5%, 15% becomes
27.75%, and 27% becomes 49.95%). Once fully 85% of the benefit becomes taxable,
however, each extra dollar of income is taxed only at the marginal rate in the bracket
into which it falls. This effect on marginal income tax rates is shown by Chart 2.
As it illustrates, there are large and erratic changes in the effective marginal income
tax rates between the threshold where Social Security benefits become taxable and
the point where they have been taxed to the limit allowable.
Figure 2. Marginal Tax Rates on Additional Income
Percent
60
50
40
30
20
10
0
$0
$5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000
Non-Social Security Income
Note: Age 65 Individual with $10,000 Annual Social Security Benefit

CRS-14
Thus, some critics argue that this approach grossly distorts the progressive tax
structure, discriminates against those with higher incomes, and is a strong
disincentive to work, save, and invest.
Opponents say the 1993 law particularly discourages work effort when its
interaction with the Social Security earnings test is included. The earnings test
reduces the benefits of recipients who earn income from work above a certain sum
(the “exempt amount”). With modifications, this “earnings test” has been in place
since the beginning of the program, but, effective in 2000, it no longer applies to
individuals when they attain the full retirement age.2 For recipients below the full
retirement age, the law provides that recipients who will not attain the full retirement
age in 2003 may earn up to $11,520 a year in wages or self-employment income
without having their benefits affected. For earnings above these amounts, recipients
lose $1 of benefits for each $2 of earnings. There is a different reduction factor and
exempt amount in the year recipients attain the full retirement age. In 2003, these
individuals can earn up to $30,720 a year in the months before they attain the full
retirement age. For earnings above these amounts, they lose $1 in benefits for each
$3 of earnings. Another way of looking at it is that each dollar of income above the
exempt amount reduces a dollar of benefits by 50% (in the year a person attains the
full retirement age, the reduction is 33% for months before attainment). The earnings
test applies only to earned income and not to savings, investments, and the like.
A frequent criticism of the earnings test is that it often creates a strong financial
disincentive to work, or to increase work effort beyond minimal levels. There is a
strong disincentive to work if earnings would cause a beneficiary not only to lose a
portion of his benefit but also to become liable for payment of income taxes for all
or part of his remaining Social Security as well.
Actually, the combination of the Social Security earnings test and the taxing of
benefits provision has a smaller effect on marginal income tax rates than just the
taxing of benefit provision alone. The reason is that the earnings test, by reducing
benefits for each extra dollar earned, automatically decreases the amount of Social
Security benefits that can be taxed. In other words, the two “taxes” are not additive.
The interactive effects are complicated (see archived CRS Report 89-40, Social
Security: Issues in Taxing Benefits Under Current Law and Under Proposals to Tax
a Greater Share of Benefits). Nevertheless, under some scenarios the effect of
additional income from work is to increase the effective marginal tax rate (earning
test plus federal, state, and local income taxes and Social Security taxes) to over
100%, so that the individual loses money from working.
2 For more on the earnings test and proposals to liberalize or eliminate it, see CRS Report
98-789, Social Security: Proposed Changes to the Earnings Test, by Geoffrey Kollmann,
updated regularly.