Tax bite leaves seniors growling 

By: Kathy M. Kristof
Chicago Tribune, July 3, 2001

Social Security benefits are hit 

While lawmakers scrambled to provide a massive tax cut for Americans, senior citizens such as Lonell Spencer, a 72-year-old retired machinist who lives in Arcadia, Calif., wondered why they'd been left out. 

Thanks to a 1993 law that dramatically increased the amount of Social Security benefits subject to taxation, millions of middle-income seniors -- people with incomes between $34,000 and $75,000 -- pay taxes at higher marginal rates than millionaires do. 

"This bothers me considerably," Spencer said. "I had a small inheritance and it was really unbelievable how much it was diminished by the taxation. I know it sounds weird, but this does not affect the wealthy. The only people who are hurt by this are the middle class." 

In fact, federal income taxes can gobble up more than half of any extra income a middle-class senior citizen might earn, said Mark Luscombe, principal tax analyst at CCH Inc., a Riverwoods-based publisher of tax information. 

Members of Congress and the AARP, formerly known as the American Association of Retired Persons, have been working to get the 1993 tax law repealed for years, or at least amended to make it less onerous. But now, despite the $1.35 trillion tax cut, the chances for repeal have never seemed more remote. 

Bills aimed at reducing the tax on Social Security benefits stalled in committee in both the House and Senate. 

Major tax legislation is generally an ideal vehicle for eliminating unpopular taxes. But it was impractical to try to dump the tax in this go-round, said David Certner, director of economic issues at the AARP in Washington, because almost anything that would boost the cost of the tax cut would have had little chance of surviving the compromises needed to pass the bill. 
Sen. Tim Hutchinson (R-Ark.), author of the Senate tax repeal bill, considered proposing an amendment to the Senate version of the Bush tax cut that would have rolled back the tax on Social Security benefits to its pre-1993 level. But that would have cost the federal government some $117 billion over 10 years. Hutchinson opted not to offer his amendment to avoid almost certain political wrangling, said D.J. O'Brien, a spokesman for Hutchinson. 

The AARP has even taken the repeal attempt off its current legislative agenda. 

"What's happening this year [with tax legislation] is largely driven by the president's priorities, and [the Social Security tax] was not on his priority list," Certner said. 

But seniors such as Earl Dover, an 84-year-old who lives in Hinsdale, aren't willing to let the issue die. Dover, Spencer and others have peppered their elected representatives with letters and phone calls, and they frequently contact reporters to complain about what they argue is a grossly unfair tax. 

"I figured with all this surplus money that they're going to start giving out, they could do something about this," Dover said. "But I am one man in the wilderness. You never hear anything about it." 

To understand how this happened, a little background is necessary. When the Social Security system was created in 1933, benefits weren't taxed. That changed in 1983 when Congress slapped a tax on up to half of the Social 

Security payments received by many taxpayers whose provisonal income, which is calculated by adding half of the Social Security benefits to adjusted gross income, exceeded $25,000 for singles or $32,000 for married couples filing jointly. 

The amount of Social Security benefits subject to tax would then be the lesser of 50 percent of the amount that the provisional income exceeded the base amount or 50 percent of Social Security benefits. 

For a couple with an annual income of $35,000 in wages and pensions and $20,000 in Social Security, the provisional income would be $45,000, or $13,000 over the base amount. They would then pay tax on $6,500, which is less than half of their Social Security benefits ($10,000). 

In this case, that translates into a $1,820 tax on their Social Security benefits, based on their marginal tax rate of 28 percent. 

Things got even worse for seniors with passage of the 1993 tax bill, which increased the maximum portion of a person's Social Security benefits that could be taxed from 50 percent to 85 percent. Although the tax was advertised as a levy on "wealthy" recipients, retirees with incomes as low as $34,000 if single or $44,000 if filing jointly were subject to the tax. 
Because more of their Social Security benefits were now subject to taxation, the couple in the above example saw the federal income taxes on their benefits rise to $1,918, or $98 more than before. 

In this case, taxable Social Security on the first $12,000 of the amount over provisional income ($44,000 minus $32,000) equals $6,000 (using the old 50 percent rate) and taxable Social Security on the remaining $1,000 ($45,000 minus $44,000) equals $850 (using the new 85 percent for any amount over $44,000). The amount of benefits subject to tax would then be the lesser of the sum of these amounts ($6,850) or 85 percent of Social Security benefits ($17,000, or 85 percent of $20,000). 

Worse still, for each $1,000 that a retired couple's income increases, they could end up paying more than half of the added income in tax. That's because the $1,000 would make an additional $850 of their Social Security benefits (85 percent of $1,000) taxable. So instead of paying ordinary income tax on $1,000, they pay tax on $1,850. 

In effect, $1,000 in extra income costs them $518 in tax. That's an effective marginal tax rate of 51.8 percent, well above the top marginal rate of 39.6 percent now paid by married couples making more than $288,000 a year. 

"It is a form of double taxation, a heightened form of double taxation," O'Brien said. 

What especially troubles Spencer is that the income thresholds that trigger taxes on Social Security income are not adjusted for inflation. If seniors simply withdraw more from their pensions to keep up with inflation, they get hit harder by the double tax. 

Moreover, because of inflation, relatively poorer retirees get sucked into the Social Security tax each year. Fewer than 10 percent of all retirees paid tax on Social Security income when the 50 percent tax was first imposed, but roughly 32 percent of recipients find their benefits taxable today. Some 9 million retirees pay tax on 85 percent of benefits, O'Brien said. 

"Don't ever listen to people telling you that you're going to be in a lower tax bracket when you retire," Spencer said. "I would be in a lower bracket if it wasn't for Social Security, but because of this tax, I pay more than I ever have." 

If the law isn't changed, at least to index the income levels to inflation, Baby Boomers will be forced into the Social Security tax bubble at poverty-level incomes, Spencer said. 

Still, it's tough to eliminate a tax once it's been implemented, especially one that brings in so much revenue, O'Brien said. Nonetheless, he said, Hutchinson will revive the issue later in the year. 

But for now, seniors such as Spencer and Dover will wait and wonder why retirees have been relegated to second-class status when it comes to middle-class tax cuts. 

"Baby Boomers just don't understand. Everybody tells them to save, but there's this Catch-22," Spencer said. "If you save, you end up paying more tax on your Social Security." 

Global Action on Aging
PO Box 20022, New York, NY 10025
Phone: +1 (212) 557-3163 - Fax: +1 (212) 557-3164


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