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 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2021–
Change in Revenues 17.4 35.8 37.9 39.9 41.9 48.7 55.8 58.2 60.5 62.8 172.9 458.7

Data source: Staff of the Joint Committee on Taxation.
This option would take effect in January 2021.

Under current law, roughly two-thirds of the benefits paid by the Social Security and Railroad Retirement programs are not subject to the federal income tax because most recipients have income below a specified threshold. By contrast, distributions from defined benefit pensions (plans offered by some employers that provide a fixed benefit amount upon retirement based on a predetermined formula) are taxable except for the portion that represents the recovery of an employee’s “basis”—that is, the employee’s after-tax contributions to the plan.

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