Q. Your recent columns on the taxation of Social Security benefits have been real eye-openers. When I got my tax return back from my tax preparer I went through it and came up with about a 25 percent tax rate on some of my other income. This bothers me because about half of my total financial assets are in my IRA.
Since you say that this started in the Reagan era, they did a good job of not telling any body about it. You indicated that there was no backing in Congress to repeal it. Why is that? Who can we go to?
I checked the AMAC site that you mentioned. Looks like a Tea Party bunch to me. I'd like to get some more background on this surtax. Who wrote it? What necessitated it, etc.? Are there websites that one could use? —H.W., by email
A. In the early 1980s Social Security was starting to pay out more than it was taking in. The tax was part of a package of reforms that came out of the Greenspan Commission. The reforms were supposed to make Social Security solvent for 75 years. The idea of not indexing the formula for the tax has been attributed to David Stockman, a major figure in the Reagan administration. This allows the tax to creep up, year by year, with inflation.
The bill passed with broad bipartisan support. There are still a few people in office that voted for it, such as Vice President Joe Biden and Senator John McCain. About 10 years later, during the Clinton administration, the tax formula was changed. The percentage of benefits taxed increased from 50 percent to 85 percent. This is a bipartisan tax bomb with a long fuse.
It may be comforting to believe there are Republican bad guys or Democrat bad guys. But the reality is that both parties favor the tax for different partisan reasons. Republicans like the tax because it limits entitlements. Democrats like the tax because it shows their devotion to those with less income. Both parties like it because it purports to strengthen Social Security.
Members of both parties also liked the tax because it affected only 3 percent of retirees in 1984. So they got little heat from voters. By the time it affected many people, they would be long out of office.
The people who will be most affected by this tax have yet to retire. I believe we should outlaw taxes of this sort. This is a King George law— taxation without representation.
Finally, you have to be pretty sophisticated to understand how the tax works. While named a tax on Social Security benefits, you only pay the tax based on having other sources of income. How you experience it— what economists call “tax incidence”— is as a high marginal tax rate on each dollar of income from other sources. The politicians never discuss it this way, of course, because, regardless of party, they have incomes far over the narrow band of income where this tax strikes. They pay the tax, to be sure, but the bulk of of their much larger income is taxed at regular, or preferential, rates. Because of the way it is written, this tax falls most destructively on middle-income retirees. And each year it reaches people at a lower level of income.
Readers who have sent letters to their representatives and told me about it have, so far, only received unrelated double-talk letters in response.
Q. Just read your latest column on high taxes on Social Security benefits caused by other income. Does this mean we should be putting our IRA money into a Roth account instead of a traditional IRA, to reduce our taxable other income in retirement? —S.P., Austin, Texas
A. Yes, using Roth IRAs over traditional IRAs is one of the implications. It’s a no-brainer for young workers in the 15 percent tax bracket. It’s less of a certainty if you are older, already have traditional retirement accounts and are in a higher tax bracket. This, of course, assumes we can trust Congress not to make Roth withdrawals taxable.