ARLINGTON, Va. — Most Americans will pay thousands of dollars per year in Social Security taxes during their working lives on the promise that they’ll receive a government pension when they reach a certain age. Their employers will “contribute” an equal amount.
When they finally become eligible for these benefits, however, they will learn another reality: If they or their spouse are still working and their earnings exceed a certain threshold, the government will tax their Social Security benefits.
This double taxation is not only unfair and imposes punitive tax rates on seniors who choose — or are forced by economic circumstances — to stay in the workforce, it also harms the economy. As our most experienced workers, seniors contribute greatly to workplace productivity; discouraging their labor force participation through punitive taxation harms everybody.
Social Security is in dire financial condition, already operating in the red — eight years earlier than the program’s trustees expected. The program must be reformed. But any reform should, for both simple fairness and to promote economic growth, repeal the 1993 tax on Social Security benefits.
Historically only 50 percent of Social Security benefits were taxable: the portion paid by employers. Since 1993, however, individual seniors with incomes exceeding $34,000 and couples with more than $44,000 in income have been taxed on 85 percent of their Social Security benefits. Because these threshold amounts aren’t indexed to inflation, the unfair levy hits more and more seniors every year.
For most Americans the 25 percent marginal tax rate kicks in this year at $34,000 — meaning they will pay $25 in taxes for every $100 they earn above that. A senior earning the same $34,000 will pay a higher rate. For every additional $100 the senior earns, he or she will pay $25 in income taxes, plus an additional $21.25 on the previously untaxed Social Security benefits — 25 percent of the 85 percent that are now taxable, or 21.25 percent overall. This gives the senior an effective marginal tax rate of 46.25 percent.
This double-taxation creates a strong incentive for some of America’s most knowledgeable and productive workers to cut back or leave the labor force.
We learned — or should have — from earlier tax cuts during the Kennedy and Reagan Administrations that marginal income tax rates have an enormous impact on economic growth.
High marginal rates encourage some our best workers to stop working. Employers are forced to replace them with less experienced workers who produce less, slowing the growth of both the company and the economy — thus resulting in fewer jobs.
The Social Security system for the first time this year will send out more in payments than the government collects in taxes. Some will argue that this is good reason to continue double-taxing Social Security benefits. It isn’t.
Social Security’s premature financial woes have been caused primarily by the bad economy; ending the double taxation of Social Security benefits would help give the economy a lift.
Social Security’s financial problems can only be solved with economically sound, fair policies that don’t rely on gimmicks like the 1993 double-taxation provisions. The system needs to be modernized in a way that promotes economic investment and growth, preferably through individual retirement accounts that would give workers a better deal than the current system even promises.
More taxes, fees, or benefit cuts would only exacerbate the biggest problem with Social Security, which is that it offers a meager return to workers who deserve better.
The best way to finance the transition to a reformed Social Security system is to reduce excessive federal spending, not punish seniors with an unfair, discriminatory double tax.
Phil Kerpen is vice president for policy at Americans for Prosperity, a nonpartisan organization of grassroots leaders who engage citizens in the name of limited government and free markets on the local, state and federal levels. Readers may write him at AFP, 2111 Wilson Boulevard, Arlington, VA 22201.
