Proposals to modify the taxation of Social Security benefits: options and distributional effects

This article presents simulation estimates of the income-distributional effects in 1994 of several proposals to modify the taxation of Social Security benefits under the Federal personal income tax. Under the benefit-taxation provisions that have been in effect since 1984, up to 50 percent of benefits are included in taxable income for taxpayers with incomes above certain thresholds. In 1994 about 20 percent of beneficiary families will pay a larger income tax as a result of these provisions. Because of the benefit taxation thresholds, the affected families are concentrated in the upper half of the income distribution: about 70 percent of these families have incomes that put them in the top 30 percent of families by income. If the current taxation thresholds were kept and the percentage of benefits includable in taxable income were raised above 50 percent, the tax effect would remain concentrated on the upper income families. If, on the other hand, the percentage includable were kept at 50 percent while the taxation thresholds were lowered or eliminated, more beneficiary families with incomes in the middle deciles would become affected. The lowest income beneficiary families, however, would remain unaffected, because their benefits would be protected from income taxation by exemptions and the standard deduction. The simulations indicate that only a very few families in the bottom 20 percent of families by income would be affected even if the benefit taxation thresholds were eliminated entirely.