Two Candidates with a Nasty SecretIn the coming election, two major candidates share a nasty secret. Twenty-five years ago the candidates voted for legislation that now hits middle-class retirees hard. Because of this legislation, many retirees now face effective income tax rates of 46 percent--- even though their household income may be less than $100,000.

Yet these same candidates are claiming that, if elected, they will help the middle class. Each candidate claims he will provide tax breaks for the 95 percent of all households with incomes under $250,000.

For retirees, that simply isn’t true.

Here’s the story.

In April 1983, following the recommendations of the Greenspan Commission, Congress approved major reforms of Social Security. They increased the employment tax on the self-employed. They reduced benefits for future retirees by increasing the age for receiving full benefits. And they accelerated planned increases in the employment tax.

Washington then claimed that Social Security was safe for at least 75 years. The same change also created a large surplus for Social Security. Over the next 25 years that surplus was squandered. IOUs were put in the Social Security trust fund.

The reforms also introduced the taxation of Social Security benefits. If the combination of one-half of your Social Security benefits and other income sources exceeded $32,000 for a couple or $25,000 for a single taxpayer, a portion of your benefits would become taxable. (During the Clinton administration, a still higher tax was imposed.) There have been multiple efforts to eliminate the tax, but they have not been successful.

Back in 1983 the tax affected very few people. Only a small portion of all retirees had enough income to pay the tax.

But the legislation had an odd twist.

Unlike virtually everything else in the entire tax code, the threshold for taxing benefits--- $32,000 for a joint return, $25,000 for a single return--- was not indexed to inflation. They are the same today as they were 25 years ago.  Had they been indexed to inflation, the thresholds would now be $70,389 for a joint return and $54,991 for a single return.

That’s quite a difference.

As a consequence, more retirees pay taxes on their benefits every year. Due to the way the tax is structured, retirees experience this tax as a higher tax rate on pension, savings, and investment income that they have in addition to Social Security benefits.

The October issue of Money magazine has an excellent article explaining exactly how this tax works. It also points out that while only 10 percent of retirees were subject to the tax in 1984, 33 percent are paying it this year, and 43 percent are expected to be paying it in 2018.

The current 33 percent figure is a lot larger than it seems.

According to the Social Security Administration, Social Security benefits account for 90 percent, or more, of all income for a stunning 41 percent of all households. So only the 59 percent of households with some savings are likely to be taxed. Do the math, and 56 percent of all households that have saved any money for retirement are already paying taxes on their Social Security benefits.

These are not rich people. They are just people who saved or had the good fortune to have a retirement pension. They are middle class.

Many, ironically, are the same folks who responded to programs Congress created to encourage saving--- tax-deferred retirement programs such as IRAs, 401(k) plans, and 403(b) plans. Instead of retiring to a lower tax bracket, savers now retire to a higher tax bracket simply because they had saved some money--- even though their income may be well under $100,000.

So, which candidates voted for this diabolical tax?

Of the 100 senators in office in 1983, only 20 are still in office today.  Sen. Joe Biden, the Democratic Party candidate for vice president, was one of the 58 “yeas” in the Senate.

Sen. John McCain, the Republican Party candidate for president, was a congressman in 1983. He was one of 243 votes in the House of Representatives.

Regardless of party, there are only two conclusions. Either they don’t know what they are doing, or we can’t trust them.

Take your pick.

On the web:

Summary of the 1983 amendments to Social Security

Vote tallies for the 1983 Social Security amendments

Meet the Diabolical Tax, the alternative minimum tax for the retired (August 6, 2008)

Coming Soon. Tax Inflation (July 25, 2008)

Inflation Calculator

Social Security Chart Book/Fast Facts 2008