Tax reform is in the air— again. This means we will be subject to the wretched posturing of politicians saying they want to help the middle class. They will do this by giving us some of our income back and calling it tax relief

Well, I have a suggestion.

Start by providing tax relief for embattled middle-income seniors. Start helping middle-class Americans by ending the taxation of Social Security benefits. It will increase consumer spending by about $33 billion. It will enable some seniors to retire. And when they retire it will create a job opportunity for a young person.

You can understand the enormous impact of this tax by considering the case of Bill and Jane Middle. Together, their Social Security benefits total $32,000 a year. They also have another $32,000 a year in income from other sources. If Social Security benefits were not taxed, their federal income tax bill would be $933. But since some of their benefits are subject to taxation, their actual tax bill will be $1,935. That’s an increase of $1,002.  Their tax bill is more than double what they would otherwise have paid.

No one could argue that doubling someone’s’ income tax bill is a non-event. And with a total income of $64,000, no one would call them fat cats. They are nowhere near the top 10 percent, let alone the 1 percent.

But that’s not how the politicians discuss them. The usual argument against eliminating the tax is that it only affects a few people who enjoy plenty of income. There was a time when that was true, but it was 30 years ago. In 1984, Congress passed the tax as part of a major Social Security reform. At the time, Social Security Trustees made a calculation.  Only three percent of Social Security beneficiaries would pay any tax. So no one cared.

But the formula for triggering the tax is one of the few items in the entire tax code that is not indexed to inflation. As a consequence, the number of people paying the tax has increased each year. Today about 30 percent of all seniors pay this tax. You can also be sure that more future retirees will pay this tax. (See: Introducing the Disgruntled Retiree Index.)

So let’s explore how this tax hits. I used TurboTax to do the income tax calculations. I did calculations for the income tax bill of couples filing joint returns. Social Security incomes ranged from $24,000 to $48,000. I used the same range for other sources of income such as IRA withdrawals, pensions, interest and wages. Then I calculated the same tax return as if benefits were not taxed.

The return calculations represent retirement incomes from $48,000 to $96,000. For many, that's more than comfortable. But this is definitely middle-income territory. (See table below.)

Here’s what an examination of those tax returns tells us:

The taxation of benefits more than doubles middle-income tax bills.

The typical retirees tax bill was at least twice what it would otherwise be.  The tax bill for a couple with $40,000 in benefits and $32,000 in other income increased from $933 to $2,454. That's an increase of $1,521 or 163 percent.

The tax makes taking more money from retirement accounts very expensive.

Suppose you had $24,000 in benefits and $32,000 in other income. But you needed $8,000 more of other income from your IRA. Do that and your tax bill rose from$1,561 to $3,676. That's an increase of $2,115. This implies a 26.4 percent tax rate on the extra $8,000 of income. Going from $24,000 to $32,000 in other income the tax rate is 15.35 percent. From $40,000 to $48,000 the tax rate is 28.25 percent.

If the extra money came from a part time job, you paid 7.65 percent in employment taxes. Then you paid 26.4 percent in income taxes. That's a total of 34 percent. That’s close to the highest marginal tax rate anyone pays. Yet your income only increased from $56,000 to $64,000.

Successful savers are penalized.

Our retirement account system was based on a simple idea. Invest tax-deferred today. Expect to withdraw money later at a lower tax rate. Taxing benefits turns that upside down. Middle-income savers have deferred taxes on income that would have been taxed at 15 percent ---but the taxation on benefits is experienced as a tax of 17.5 percent to 28.25 percent on retirement account withdrawals.

Thank you, Washington, for all your help.

How Much the Taxation of Social Security Benefits Increases Seniors’ Tax Bills

This table shows how income taxes change with different amounts of Social Security benefits and different amounts of income from other sources. The amounts shown are calculated for a joint return using the standard deduction. The same principle, with different amounts, would apply for a table based on the taxes paid by a senior who filed as a single. FIT= Federal income tax

Other Income
Social Security $24,000 $32,000 $40,000 $48,000
FIT with Benefits $333 $1,561 $3,676 $5,936
FIT without Benefits   $56 $   933 $1,764 $2,943
Tax Increase $277 $   628 $1,912 $2,993
FIT with Benefits $533 $1,935 $4,195 $6,455
FIT without Benefits $  56 $   933 $1,764 $2,943
Tax Increase $477 $1,002 $2,431 $3,512
FIT with Benefits $733 $2,454 $4,714 $6,974
FIT without Benefits $  56 $   933 $1,764 $2,943
Tax Increase $677 $1,521 $2,950 $4,031
FIT with Benefits $1,092 $2,973 $5,233 $7,493
FIT without Benefits $     56 $933 $1,764 $2,943
Tax Increase $1,036 $2,040 $3,469 $4,550

Next Week: Another unfortunate wrinkle in the taxation of Social Security benefits