Exempting Social Security Benefits from Income Tax Is Unsound and Fiscally Irresponsible

On Wednesday, former President Donald Trump indicated he would support exempting Social Security benefits from income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. . Policymakers in Congress have introduced similar proposals over the last two years, arguing that the exemption would help retirees financially during high inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and economic uncertainty.

Exempting Social Security benefits from income tax would increase the budget deficit by about $1.6 trillion over 10 years, accelerate the insolvency of the Social Security and Medicare trust funds, and create a new hole in the income tax without a sound policy rationale.

The tax treatment of Social Security benefits can be a confusing subject for taxpayers. Each year, the Social Security Administration (SSA) adjusts Social Security benefits for inflation, much like how certain aspects of the tax code are indexed for inflation. In 2023, for example, Social Security recipients received an 8.7 percent cost-of-living adjustment, reflecting unusually high inflation from 2022 to 2023.

The tax treatment of Social Security benefits is complicated and can trip up taxpayers and tax experts alike. That’s because the tax code treats Social Security benefits differently from other types of income. First, taxpayers calculate their “combined income,” defined as their adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” (AGI), tax-exempt interest income, and half of their Social Security benefits.

Taxpayers who earn less than $25,000 (single filers) or $32,000 (joint filers) in combined income pay no tax on their benefits. Households earning between those thresholds and up to $34,000 (single filers) or $44,000 (joint filers) pay tax on up to 50 percent of their benefits. Above those levels, up to 85 percent of benefits are taxed.

Income tax revenue collected from Social Security benefits is allocated to the Social Security and Medicare trust funds. The revenue from taxation of up to 50 percent of benefits is dedicated to the Social Security Old-Age, Survivors, and Disability Insurance (OASDI) trust fund, while the remainder goes to the Medicare Hospital Insurance trust fund.

Exempting all Social Security benefits from income tax would therefore reduce revenue going to Medicare and Social Security. According to data from the 2024 Social Security and Medicare trustees reports, the trust funds will collect about $95.3 billion in revenue from income tax in 2024, rising to over $228 billion by 2033 as the population ages—a total of $1.6 trillion from 2024 to 2033.

Exempting all Social Security benefits would likely accelerate the insolvency of the trust funds. For Social Security (including the disability portion of the program), it may move insolvency up two years, from 2035 to 2033, and for Medicare, it may move it up six years, from 2036 to 2030.

Using Tax Foundation’s Taxes and Growth model, we estimate the proposed exemption would reduce tax revenue by about $1.4 trillion from 2025 to 2034, measured on a conventional basis. Factoring in economic effects and revenue feedback, the dynamic revenue loss would total about $1.3 trillion. Our estimate uses Congressional Budget Office (CBO) forecasts for taxable Social Security benefits, which may differ from the assumptions used by the trustees.

Exempting benefits from income tax would reduce marginal income tax rates for benefit recipients, boosting their incentives to work, save, and invest. The overall positive effect on the economy is small relative to the reduction in tax revenue, increasing long-run GDP and American incomes by about 0.1 percent and adding about 64,000 full-time equivalent jobs.

The proposed income tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. would increase after-tax incomes by about 0.6 percent on average in 2025, ranging from no change for the bottom 20 percent of taxpayers to a 1.1 percent increase for those in the 80^th to 90^th percentiles.

The bottom 20 percent would see no benefit from the proposal on a conventional basis as they are already in the 0 percent bracket for benefits under current law. Higher earners would see a larger benefit, which tapers off for the top 10 percent of earners as benefits make up a smaller share of their total after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize their earnings. .

In the long run on a dynamic basis, all income groups would see a slight increase in after-tax incomes, averaging about 0.9 percent.

Table 2. Distributional Impact of Exempting Social Security Benefits from Income Tax (Percent Change in After-Tax Income)

Percentile	Income Threshold at Beginning of Band	2025, Static	2034, Static	Long-Run, Dynamic
0% - 20.0%	$0	0.0%	0.0%	0.1%
20.0% - 40.0%	$13,900	0.1%	0.1%	0.1%
40.0% - 60.0%	$29,800	0.3%	0.5%	0.5%
60.0% - 80.0%	$55,400	0.7%	1.0%	1.1%
80.0% - 100%	$96,200	0.7%	1.0%	1.0%
80.0% - 90.0%	$96,200	1.1%	1.4%	1.5%
90.0% - 95.0%	$137,000	0.9%	1.2%	1.2%
95.0% - 99.0%	$191,500	0.6%	0.9%	0.9%
99.0% - 100%	$434.800	0.2%	0.3%	0.3%
Total		0.6%	0.9%	0.9%

Source: Tax Foundation General Equilibrium Model, July 2024.

Carving out Social Security benefits from the income tax entirely is neither fiscally responsible nor sound tax policy. It makes the most sense to include a portion of benefits in the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .

Under the current tax code, employees cannot deduct their portion of payroll taxes paid from their income tax liability, but employers can deduct their portion of the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. as an ordinary business expense (with exceptions for nonprofits or firms incurring losses). One way to think about this is that half of the contribution from the payroll tax is treated like a traditional retirement account, where there is a deduction for saving up front, and half is treated like a Roth account, where tax is paid up front. This means that a portion of the Social Security benefits should be taxed when received to match up with tax-exempt contributions.

In addition, the portion of benefits exceeding contributions should be subject to tax; otherwise, Social Security benefits would be treated preferentially over similar types of income, like benefits from private sector pensions. In 1993, SSA estimated the present value of tax contributions to Social Security was equal to less than 15 percent of lifetime benefits, meaning up to 85 percent of benefits could be taxed without risking double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. (the 85 percent share may have shifted somewhat since then, but probably not a great deal).

No matter how we think about them conceptually, Social Security benefits should still be considered income, and, as such, it is proper to include at least a portion of these benefits in the income tax base. Broad exemptions from the income tax would continue the long-running trend of narrowing the income tax base at the cost of higher tax rates while also accelerating the insolvency of the very programs the beneficiaries rely on.

There are other, more sound policy options for policymakers to consider for Social Security beneficiaries. The combined income tax thresholds were originally established in 1984 and updated in 1993, and have not been indexed for inflation.

The lack of indexing means a larger portion of Social Security benefits are being taxed over time due to bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. , and this is especially true during times of high inflation. In 1999, about 19.5 percent of Social Security benefits were taxable, rising to about 33 percent of benefits in 2017 and about 37.9 percent of benefits in 2022. Ordinary income tax brackets were indexed in 1981, and the brackets for Social Security benefits should be treated no differently.

Indexing the combined income thresholds for inflation is a sensible reform if paired with an appropriate offset for the lost revenue. Exempting benefits from tax altogether increases complexity by creating another preference in the tax code and weakens entitlements that are already headed toward insolvency if they are not more broadly reformed by policymakers.

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