Trump plan to end taxes on Social Security benefits would help high earners

On the campaign trail, President Donald Trump touted a plan to eliminate income taxes on Social Security benefits.

Now in the White House, Trump administration officials told CNBC.com last week that the president “doubles down” on that promise.

A bill to eliminate those levies — the Senior Citizens Tax Elimination Act — was recently reintroduced in the House.

Yet, nixing taxes on Social Security benefits may reduce U.S. government revenues by $1.5 trillion over 10 years and increase the federal debt by 7% by 2054, according to a new analysis by the Penn Wharton Budget Model, a nonpartisan, research-based initiative at the University of Pennsylvania.

For some high-income households, the policy change may result in gains of up to $100,000 over their lifetimes, the research also found. Yet, individuals under age 30 — and particularly people who have not yet been born — may face the largest losses as the federal debt increases and incentives to work and save for retirement decline.

For beneficiaries who have paid into the program for their entire working lives, there is a sense that their benefits should not be taxed, said Kent Smetters, professor of business economics and public policy at the University of Pennsylvania’s Wharton School.

When Social Security reform was passed by Congress in 1983, benefits became subject to taxes for the first time. Then in 1993, lawmakers added a second taxation tier.

Today, beneficiaries who have what is known as “combined income” below $25,000 if they file taxes individually — or $32,000 if they are married and file jointly — generally pay no taxes on their Social Security benefits, the Penn Wharton Budget Model notes.

Combined income is the sum of adjusted gross income, non-taxable interest and half of Social Security benefits.

Individual beneficiaries may pay taxes on up to 50% of their benefits on combined income between $25,000 and $34,000, or for married couples with between $32,000 and $44,000.

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Up to 85% of the benefits would be subject to taxation if they have more than $34,000 in combined income; for married couples that applies if their combined income is more than $44,000.

Those thresholds are not adjusted for inflation, which means more people over time have become subject to taxes on their Social Security benefits.

Any changes to Social Security would require a bipartisan consensus from both the House and the Senate.

Both Congressional chambers overwhelmingly recently voted to push through the Social Security Fairness Act, a new law that ends benefit reductions for individuals who also receive pensions from work that did not include payment of Social Security payroll taxes.

That change is estimated to cost almost $200 billion over 10 years and move the Social Security Trust Fund insolvency six months closer, according to the Congressional Budget Office. Before the change, Social Security’s trustees projected the program’s combined funds may run out in 2035, at which point 83% of retirement, disability and other benefits will be payable.

Eliminating taxes on Social Security benefits would be more expensive — reducing revenues by $1.5 trillion over 10 years — according to the Penn Wharton Budget Model, provided the policy change is implemented in 2025. Social Security’s trust fund depletion date would move two years closer, the analysis found.

Because Congressional lawmakers are already dealing with a “really alarming budget situation,” there will be some “pretty strict limits on the tax cuts that would be allowed,” said William McBride, chief economist at the Tax Foundation.

In particular, if Republican efforts to extend the Tax Cuts and Jobs Act are successful, that will cost about $4 trillion, he said. That tax package, which was originally passed in 2017, excludes Social Security.

That doesn’t leave much room for exempting Social Security income from taxes or many of the other “more expensive” ideas that Trump mentioned on the campaign trail, McBride said.

Importantly, changes to Social Security cannot be enacted through the reconciliation process, which may be used to fast-track other budget and tax measures.

If taxes on Social Security benefits are eliminated, those at the top of the household income distribution would see the largest tax reductions, according to the Penn Wharton Budget Model. That would range from annual gains of $1,625 to $2,450 in 2026, and it would increase to $4,075 to $5,080 by 2054.

Lower-income earners would see much smaller gains, with those in the second and third quartiles receiving a bump of between $15 and $340 in 2026 and between $275 and $1,730 in 2054, Wharton’s analysis finds.

While all future generations would be worse off, the pinch would be more pronounced for those born further in the future, according to the analysis.

To be sure, another proposal in Congress has likewise called for eliminating taxes on Social Security benefits while also requiring high earners to pay more taxes into the program to help mitigate the benefit increases.

However, the concern with those changes is that while older people would see higher benefits, it would put financial pressure on younger generations, Smetters said.

Economists often refer to this as implicit debt, where an intergenerational imbalance causes future generations to be saddled with higher costs.

“Who pays for that benefit is actually younger people,” Smetters said. “They now pay higher taxes to pay for that.”