Tax Social Security and Railroad Retirement Benefits in the Same Way That Distributions From Defined Benefit Pensions Are Taxed

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of dollars 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2015-2019 2015-2024
Change in Revenues 17 36 37 39 41 44 46 48 51 53 171 412

Source: Staff of the Joint Committee on Taxation.

Note: This option would take effect in January 2015. Estimates are relative to CBO’s April 2014 baseline projections.

Under current law, recipients of Social Security and Railroad Retirement benefits with income below a specified threshold pay no taxes on those benefits. If the sum of their adjusted gross income (excluding any Social Security benefits), their nontaxable interest income, and one-half of their Social Security and Tier I Railroad Retirement benefits exceeds that threshold, up to 50 percent of the benefits are taxed. Above a higher threshold, as much as 85 percent of the benefits are taxed. By contrast, distributions from defined benefit plans are taxable except for the portion that represents the recovery of an employee’s “basis”—that is, his or her after-tax contributions to the plan.

This option would treat the Social Security and Railroad Retirement programs in the same way that defined benefit pensions are treated—by defining a basis and taxing only those benefits that exceed that amount. For employed individuals, the basis would be the payroll taxes they paid out of after-tax income to support those programs (but not the equal amount that employers paid on their workers’ behalf). For self-employed people, the basis would be the portion (50 percent) of their self-employment taxes that is not deductible from their taxable income.