The Retired Investor: Taxing Social Security Benefits Hurts Seniors

In this election season of competing promises, one idea stands out as a good way of redistributing income from the haves to the have-nots. More than 70 million needy Americans would benefit directly by cutting federal taxes on Social Security.

 

Let's face it, retirees have been getting the short end of the stick for a long time. For years, with interest rates at practically zero, retired savers, unwilling to bet on the stock market, have received scanty returns on their savings.

 

Fast forward to the pandemic and its aftermath. Elderly Americans, if they were lucky enough to dodge serious sickness or death as the highest-risk segment of the population, they were faced with burgeoning inflation for everything from food to health care on a fixed income.

 

Sure, interest rates spiked higher, but not nearly enough to keep up with inflation. To make ends meet, seniors were forced to find jobs bagging groceries, waiting on tables, or acquiring whatever menial, minimum-wage job they could find. To make matters worse, many of those part-time jobs ended up pushing their income level over the threshold. What threshold, you might ask? The answer lies in the past.

 

Before 1984, Social Security benefits were exempt from federal income tax. But Congress, faced with a Social Security funding crisis of their own making, then decided to tax a portion of these benefits, with the share gradually increasing as a person's income rose above a specified threshold. Today, if you file single on your tax return and earn above $34,000, or file jointly and make above $44,000, 85 percent of your benefits are taxed. Up to 50 percent of benefits can be taxed if you make between $25,000 and $34,000 (or between $32,000-$44,000 if filing jointly).

 

And those income levels have never been adjusted for inflation over more than 30 years. Bottom line, by eliminating federal income tax on Social Security, many retirees would be given a bit more financial breathing room, especially those who receive other types of taxable income such as wages or distributions from retirement accounts. All but 12 state governments are already recognizing this issue and do not tax Social Security benefits.

 

Advocates of tax-free benefits argue that the present tax structure is not only extremely regressive but discourages seniors from working, even when they want to.

 

How does that fit with all those free-market capitalists out there who extoll the benefits and rewards of American labor? It doesn't. But it gets worse! Retirees have already paid taxes on their Social Security benefit contributions via the payroll tax during their working lifetimes, so retirement benefits are taxed twice.

 

Last year, two Florida congressmen, Daniel Webster and Thomas Massie, introduced a bill, the Senior Citizens Tax Elimination Act, that would eliminate this double tax. Co-sponsoring the bill were 24 Republican members of Congress from across the nation. For Massie, this was the sixth time that he has reintroduced since 2012.

 

Up until now, Massie's bill has been dead upon arrival in Congress. Many politicians argue that tax-free benefits would simply worsen a social program that many in Congress and the Office of Management and Budget predict will be insolvent by 2034. Does it matter that the program brings in 90 percent of its revenue from the payroll tax on earned income, and only 4 percent of the total is derived from the taxation of benefits? That 4 percent is a drop in the budget compared to what we spend every year on so many government boondoggles but an "every little bit helps" attitude permeates the discussion in the Capitol's corridors.

 

Democrat Rep. Angie Craig, from Minnesota, thinks she has solved this hurdle. Her bill, the You Earned It, You Keep It Act, introduced this year, would eliminate taxes, but at the same time increase the Social Security wage base. It would mean that higher earners would foot the bill for eliminating the federal tax on retirement benefits.

 

Craig's bill would increase the wage limit to over $250,000, which would mean that high earners would pay a 6.2 percent payroll tax on almost $100,000 more of their wages. The Social Security Office of the Actuary believes her bill would ensure payments could be made through 2054, rather than 2034 while benefiting retirees for decades ahead.

 

The biggest challenge would be getting enough support on both sides of the aisle to amend Social Security laws. That would take 60 votes in the U.S. Senate. The problem is that neither party has held a supermajority of 60 seats in the upper house of Congress since 1979. But times are changing.

 

At least one of the candidates is savvy enough to see the political benefit of eliminating this double tax on 70 million voting seniors. Populism has swept the country and with it the recognition that income inequality in the U.S. needs to be reversed if this country has any chance of righting the wrongs of the last 40-50 years. To do that, a bottom-up approach to economic and political policies must be enacted. Where better to start than with an unjust tax that is already despised by more than 90 percent of American seniors? Is anyone in Chicago listening?

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.