In this installment of the Five Minutes On series, Tax Notes contributing editors Robert Goulder and Joseph J. Thorndike examine the history of taxing Social Security benefits and former President Trump’s proposal to stop taxing them.
Five Minutes On is a video series produced by Tax Notes. This transcript has been edited for clarity.
Robert Goulder: Hello, I’m Bob Goulder, contributing editor with Tax Notes. You know that the presidential elections are getting closer when the candidates start to throw around tax proposals. Well, we’ve seen several of them lately, and one that stands out is former President Trump’s idea to exempt Social Security benefits. Currently, a portion of those benefits are taxable depending on how much other income a person earns.
Now to help me work through this issue is my colleague Joe Thorndike, also a contributing editor with Tax Notes. Joe, thank you for joining us. Let me ask you, were these benefits always taxable?
Joseph J. Thorndike: So no, Bob, they were not. They were tax free for quite a long time. So just a couple years after Congress creates Social Security in 1936, the Treasury decides that benefits, which looked a lot like a pension, should get special treatment. So while private pensions would be taxable, Social Security would be exempt. Technically, the Treasury decided that they would treat benefits like a gratuity or a gift from the government.
Robert Goulder: OK. When did that change?
Joseph J. Thorndike: So that changed in 1983, and it changed because Social Security was running out of money. That funding crisis, it came about for several reasons. One was high inflation. Also, wages were growing sort of slowly. And partly because a long-term financing deficit had been built into the program for ages. Congress had seen this coming and had tried to shore up the program in the late 1970s, but they really didn’t get the job done. And in the spring of 1982, the official scorekeepers in Washington warned that insolvency for the program was just around the corner, like a little more than a year out.
Enter President Ronald Reagan here. He had already seen this coming, and he had suggested a set of Social Security reforms, which were mostly about cutting benefits. And as you would expect, people pretty much hated that idea.
So Reagan decided to do what politicians do when they have a really hard problem that they can’t figure out how to solve: He appointed a commission headed up by Alan Greenspan. He’s a Republican economist that most people today probably remember as a Fed chair. And it included eight Republicans and seven Democrats.
That commission then went on to do what commissions typically do, especially when they’re evenly divided between party lines: They deadlocked. After a year of regular meetings, they couldn’t agree on how to save Social Security because basically the Republicans didn’t want to accept any tax increases and the Democrats didn’t want to accept any benefit cuts.
And then Bob Dole comes to the rescue. He’s a member of the commission, a Republican senator from Kansas, and he’s also the chair of the Senate Finance Committee at the time. And with just a few weeks to go before the commission’s timeline runs out, he publishes an op-ed in The New York Times that says, “We should have some sort of compromise.” And he even opened the door to a tax increase. So that op-ed, it basically gives everyone permission to ease up a little, especially the Republicans, and everyone jumped on the idea.
Robert Goulder: What did the resulting compromise look like?
Joseph J. Thorndike: That compromise looked exactly like you would expect a compromise to look: It included both benefit cuts and tax increases. And so let’s talk about those taxes, since we’re talking about them again in 2024.
The Greenspan Commission suggested that relatively affluent taxpayers — and that would be people at the time making more than $20,000, or couples more than $25,000 — that they should pay income taxes on 50 percent of their benefits. Adjusted for inflation, those numbers would be like $60,000 and $75,000 today. Congress basically accepted that idea, and it’s been part of the law ever since. And lawmakers at the time defended their decision by saying — surprise, surprise — that “Social Security was a lot like a pension and should be taxed like other pensions.”
Robert Goulder: OK, Joe. Now here’s what I really want to know: How does today’s Social Security funding crisis compare to that of 40 years ago?
Joseph J. Thorndike: All right, so our next Social Security crisis, it’s within sight. It should arrive in the early 2030s — probably in 2033, according to current estimates. So that’s soon, but not nearly as imminent as the crisis in 1983. And that’s, I guess, good news.
But more time means less urgency, and Congress typically waits until the very last second until they do anything about a problem. So that’s bad news. And here’s the really bad news: Today’s projected shortfall is more than twice as big as the one in 1982. It’s going to take even more taxes and even larger benefit cuts to make it go away.
Robert Goulder: Wow. Well, what about Trump’s proposal to exempt these benefits? I’m thinking just mathematically that’s going to make things worse.
Joseph J. Thorndike: It will definitely make the problem worse. If we stop taxing benefits, we can expect that Social Security insolvency to arrive a year earlier. That would be 2032 instead of 2033.
Robert Goulder: There you have it: Everything you ever wanted to know about the history of taxing Social Security benefits. Thank you, Joe, and thank you everyone for watching.
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