Sunday, November 04, 2007

Why we pay taxes on Social Security benefits.

Today's Washington Post includes a column by Martha Hamiliton that explains why we pay taxes on Social Security benefits:
The policy argument was that, while workers paid taxes on the amounts they contributed to Social Security, nobody paid taxes on the amounts their employers put in. The employer received a benefit, however -- a reduction in taxable income equal to the amount contributed. Advocates of the change argued that taxes on that money should be paid when it was received, just as taxes are paid on traditional pension checks.

What became law wasn't pristine policy, however. Instead it was a political compromise designed to exempt lower-income recipients of Social Security from taxes. The rule was written to cover combined income of at least $25,000 or more for an individual and $32,000 for a married couple filing jointly. The figure for combined income was a total of adjusted gross income, interest on tax-exempt bonds and 50 percent of Social Security benefits.

But that figure was never adjusted for inflation, so now many more beneficiaries pay taxes than did originally. In today's dollars, far more people than before exceed the lower income limits. While only 9 percent of Social Security recipients were covered in 1984, 31 percent of beneficiaries will pay taxes on a portion of their benefits in 2007, according to the Social Security Administration. Essentially it's a stealth tax increase. If the floor for taxing benefits had kept up with inflation, only those who make more than $52,331.83 today would be paying taxes.

The Alternative Minimum Tax (AMT) wasn't indexed for inflation, either, and that's why it's hitting so many more people than originally intended. Why did Congress ever pass such significant financial legislation without indexing for inflation?

The article touches on some other aspects of Social Security, as well. Recommended reading.