Include Disability Payments From the Department of Veterans Affairs in Taxable Income
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||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Change in Revenues|
|Include all disability payments in taxable income||0.7||7.6||8.2||8.8||9.9||10.0||9.8||10.8||13.1||13.7||35.2||92.7|
|Include disability payments in taxable income only for veterans with a disability rating of 20 percent or less||*||0.4||0.4||0.4||0.4||0.5||0.5||0.5||0.6||0.6||1.6||4.4|
The goal of the Department of Veterans Affairs (VA) disability system is to compensate veterans for earnings lost as a result of service-connected disabilities. By law, that compensation is meant to equal the average reduction in earnings experienced by civilian workers with similar medical conditions or injuries.
Compensable service-connected disabilities are medical problems incurred or aggravated during active duty, although not necessarily during the performance of military duties. Applicable conditions range widely in severity and type, from scars and hypertension to the loss of one or more limbs. The amount of a veteran's base payment is linked to his or her composite disability rating, which can account for multiple disabilities and is expressed from zero to 100 percent in increments of 10 percentage points. Lower ratings generally reflect that veterans' disabilities are less severe; in 2017, about one in three recipients of disability compensation were rated as either 10 percent or 20 percent disabled. Beneficiaries do not have to demonstrate that their conditions have reduced their earnings or interfere with their daily functioning.
Disability compensation is not means-tested (that is, restricted to those with income below a certain amount), and payments are exempt from federal and state income taxes. Veterans who have a job are eligible for benefits, and most working-age veterans who receive disability benefits are employed. Payments are in the form of monthly annuities and typically continue until the beneficiary's death. Because disability benefits are based on VA's calculation of average earnings lost as a result of specific conditions, payments do not reflect disparities in earnings that might result from differences in veterans' education, training, occupation, or motivation to work.
Although the number of veterans in the total population is declining, the number receiving VA disability payments has risen each year. Both the share of veterans receiving disability payments and the average amount of those payments have increased. Today, about 20 percent of veterans receive disability compensation; in 2000, only 9 percent of all veterans did. In 2017, VA paid about 4.6 million veterans an average of $15,400 each in disability benefits. Of those veterans, 1.3 million had a disability rating of 20 percent or less; their average payment was $2,200.
This option consists of two alternative approaches to taxing VA disability benefits under the individual income tax. The first alternative would include all such disability payments in taxable income. The second alternative would include disability payments in taxable income only for veterans with a disability rating of 20 percent or less.
Effects on the Budget
The staff of the Joint Committee on Taxation (JCT) estimates that, if implemented, the first alternative would increase federal revenues by $93 billion from 2019 through 2028. The second alternative would raise federal revenues by a smaller amount—$4 billion—over that period, according to JCT's estimates.
The total benefits included in taxable income would be much larger under the first alternative than under the second alternative. As a result, the second alternative would raise federal revenues by a much smaller amount. Estimates of both alternatives reflect the scheduled increase in individual income tax rates that begins in 2026.
The estimates are uncertain for two main reasons. First, they rely on the Congressional Budget Office's projections of the veteran population and disability compensation, which are inherently uncertain. Second, they rely on estimates of how individuals would respond to the change in tax policy. Those estimates are based on observed responses to prior changes in policy, which might differ from the response to this option.
An argument in favor of the option is that including disability payments in taxable income would increase the equity of the tax system. Taxing VA disability payments would make tax liabilities similar among taxpayers with comparable amounts of combined income (from disability payments, earnings, and other sources). Eliminating income exclusions in the tax system moves the system toward one in which people in similar financial and family circumstances face similar tax rates. Further, military disability retirement pay—a type of disability compensation received by those who retired from service because of a disability—is included in taxable income unless it is related to combat injuries. Including VA disability benefits in taxable income would make the treatment of the two types of benefits more similar.
An argument against this option is that VA disability payments are connected to military service, which is unlike civilian employment because it confers distinctive benefits to society and imposes special risks on service members. By that logic, enhancements to pay and benefits for service members—including the current exclusion of disability compensation from taxation—could be seen as a way to recognize the hardships of military service. However, veterans are entitled to disability payments even for medical conditions unrelated to military duties, as long as those conditions were incurred while the individuals were serving on active duty. By contrast, disability benefits received by civilian workers for non-work-related injuries are taxable if the employer paid the premiums.