The large annual budget deficits projected under current law have many tax experts contemplating ways the federal government could bring in additional revenue. To help guide the debate, the Congressional Budget Office (CBO) has published a paper exploring more than 100 potential avenues for reform.
One option suggested is to “tax Social Security and Railroad Retirement Board [RBR] benefits in the same way that distributions from defined benefit [DB] pensions are taxed.” The RBR is an independent agency in the executive branch of the government created to administer retirement benefits to the nation’s railroad workers. According to CBO researchers, “under current law, less than 30% of the benefits paid by the Social Security and Railroad Retirement programs are subject to federal income tax. Recipients with income below a specified threshold pay no taxes on those benefits. Most recipients fall into that category, which constitutes the first tier of a three-tiered tax structure.”
The researchers further note that if the sum of this group’s adjusted gross income, their nontaxable interest income, and one-half of their Social Security and Tier I Railroad Retirement benefits exceeds $25,000 for single taxpayers—or $32,000 for couples who file jointly—up to 50% of the benefits are taxed. Above a higher threshold—$34,000 for single filers and $44,000 for joint filers—as much as 85% of the benefits are taxed.
The paper continues: “By contrast, distributions from defined benefit plans are taxable except for the portion that represents the recovery of an employee’s basis—that is, his or her after-tax contributions to the plan. In the year that distributions begin, the recipient determines the percentage of each year’s payment that is considered to be the nontaxable recovery of previous after-tax contributions, based on the cumulative amount of those contributions and projections of his or her life expectancy. Once the recipient has recovered his or her entire basis tax-free, all subsequent pension distributions are fully taxed … Distributions from traditional defined contribution [DC] plans and from individual retirement accounts [IRAs], to the extent that they are funded by after-tax contributions, are also taxed on amounts exceeding the basis.
“Under this option, revenues would increase by $423 billion from 2017 through 2026,” the paper suggests. “This option also has drawbacks. It would have the greatest impact on people with the lowest income: People with income below $44,000, including some who depend solely on Social Security or Railroad Retirement for their support, would see their taxes increase by the greatest percentage. In addition, raising taxes on Social Security and Railroad Retirement benefits would be equivalent to reducing those benefits and could be construed as violating the implicit promises of those programs.”