Social Security Taxation Reform: Policy Analysis and Impact Assessment

Executive Summary¶

This analysis examines eight policy options for reforming the taxation of Social Security benefits, evaluating their budgetary impacts through 2100 using microsimulation modeling with and without labor supply responses. The Committee for a Responsible Federal Budget (CRFB) requested this analysis to inform policy discussions around Social Security solvency and tax reform.

Current law subjects Social Security benefits to income taxation under a two-tier system. Benefits become taxable when combined income, defined as the sum of an individual’s adjusted gross income (AGI), nontaxable interest and half of their Social Security benefits, exceeds certain thresholds, with up to 50% of benefits taxable at lower income levels and up to 85% at higher income levels. The revenue generated from this taxation is allocated to the Social Security and Medicare Hospital Insurance trust funds.

Policy Options Analyzed¶

This study examines eight distinct approaches to reforming Social Security benefit taxation:

• Option 1 (Full Repeal): Complete elimination of Social Security benefit income taxation

• Option 2 (85% Taxation): Taxation of 85% of all Social Security benefits regardless of income level

• Option 3 (85% Taxation with Senior Deduction Extension): Combines 85% benefit taxation with permanent extension of the bonus senior deduction

• Option 4 (Tax Credit System): Replaces the bonus senior deduction with a $500 nonrefundable tax credit applied against Social Security taxation

• Option 5 (Roth-Style Swap): Eliminates benefit taxation while making employer payroll contributions taxable to employees

• Option 6 (Phased Roth-Style Swap): Gradual implementation of the Roth-style approach over multiple years

• Option 7 (Eliminate Bonus Senior Deduction): Eliminates the $6,000 bonus senior deduction (with 6$75k/$150k) from 2026-2028

• Option 8 (100% Taxation): Taxation of 100% of all Social Security benefits regardless of income level

Report Structure¶

This report is organized into five main sections:

1. Policy Options: Detailed descriptions of the eight reform scenarios analyzed

2. Methodology: Description of our microsimulation modeling approach using PolicyEngine, including estimates with and without labor supply responses

3. Revenue Impacts: Quantitative analysis of federal budgetary impacts for each option through 2100

4. Household Impacts: Distributional analysis showing how reforms affect different income groups and household types

5. External Estimates: Comparison with prior analysis from CBO, CRFB, and other organizations

Scope and Limitations¶

This analysis focuses on federal budgetary impacts and household-level distributional effects using 75-year projections (2026-2100). We present estimates both with and without labor supply responses based on CBO elasticities (doubled for workers 65+). The analysis does not evaluate:

• State-level tax implications

• Administrative implementation challenges

• Political feasibility considerations

Estimates with labor supply responses are typically within 5% of estimates without them for most options. The estimates should be interpreted as projections based on current law baseline assumptions and may vary with changes in economic conditions or policy environment.