Taxation of Social Security Benefits under the New Income Tax Provisions: Distributional Estimates for 1994
Pattison, David, Social Security Bulletin
The 1993 Omnibus Budget Reconciliation Act raised the proportion of benefits includable in income for the Federal personal income tax. This article presents estimates of the income-distributional effects of the new provision in 1994, the first year for which it is effective. Under the pre-1993 law, up to 50 percent of benefits were included in taxable income for certain high-income beneficiaries. Under the new law, some of these beneficiaries are required to include an even higher proportion of benefit--up to 85 percent. Only 11 percent of beneficiary families, concentrated in the top three deciles by family income, include more of their benefits in taxable income under the new law than they would have under the old law. Another 8 percent include the same amount of benefits under either. The remaining beneficiary families, more than 80 percent, include no benefits in taxable income under either the old law or the new.
This article presents estimates for 1994 of the effects of the change in Social Security benefit taxation introduced in the 1993 Omnibus Budget Reconciliation Act. The estimates here supplement those in Pattison and Harrington, "Proposals to Modify the Taxation of Social Security Benefits: Options and Distributional Effects," Social Security Bulletin, Summer 1993, which simulated effects for 1994 of various options for the taxation of benefits. Like the estimates in that article, the focus is on average effects by family income class rather than on aggregate revenue effects.(1) Because the old law faxed only the benefits of high-income beneficiaries, and because the new law confines itself to an even narrower group of high-income beneficiaries, the effects of the law change are confined to the upper deciles of family income.
THE NEW BENEFIT TAXATION PROVISION
The old law included up to 50 percent of benefits in taxable income for beneficiaries with incomes above certain thresholds. The new law adds a new tier of 85-percent taxation thresholds above the old thresholds. For taxpayers with incomes below the higher thresholds, there is no change from the old law. For taxpayers with incomes above the new thresholds, the new law includes a larger portion of benefits, reaching 85 percent of benefits for taxpayers with high enough incomes.
Both the old law and the new law first determine a "modified adjusted gross income" (AGI) equal to adjusted gross income (before including Social Security benefits) plus any tax-free interest income. A "provisional income" is then calculated, under both laws, equal to modified AGI plus 50 percent of Social Security benefits.
Under the old law, if provision income exceeded the taxation threshold ($32,000 for couples, $25,000 for single persons), the portion of benefits included in taxable income was equal to half the excess of provision income over the threshold, up to a maximum of 50 percent of benefits. This calculation had the effect of "phasing in" the taxable benefit at a 50-percent rate: for each extra dollar of provisional income above the threshold, another 50 cents of benefit was included in taxable income.
Under the new law, if provisional income is less than the new upper-tier taxation threshold ($44,000 for couples, $34,000 for single persons), the includable benefit will be the same as it would have been under the old law. If provisional income is greater than the upper-tier threshold, the new-law includable benefit will be the lesser of: (1) 85 percent of benefits, or (2) the sum of (a) what the includable benefit would have been under the old law, but not more than $6,000 for couples or $4,500 for single persons, and (b) 85 percent of the excess of provisional income over the upper-tier threshold. (See below.)
Let mAGI denote AGI not including benefits, plus tax-free interest; SS Social Security benefits; and T sub 50 and T sub 85 the lower-and upper-tier taxation thresholds. Then provisional income (PI) will be
PI = mAGI + . …