Simulating Reforms to Taxation of Social Security Benefits

• In Event: From Paycheck to Payout: Wealth and Income in Retirement

Abstract

We analyze how alternative approaches to taxing Social Security benefits affect program finances, household incomes, and older Americans’ work incentives. We employ PolicyEngine’s open-source microsimulation model, which integrates Current Population Survey microdata with IRS and administrative totals, projects the population and economy to 2100 using Congressional Budget Office demographic forecasts and Social Security Trustees’ economic assumptions, and incorporates age-specific labor supply elasticities.
We evaluate four policy designs:
1. Trust-fund reallocation that redirects benefit-tax revenues between the Old-Age and Survivors Insurance and Hospital Insurance funds.
2. Standard-deduction formula that replaces the current three-tier inclusion rule with a single Social Security-specific deduction.
3. Universal 85 percent inclusion that taxes a constant share of benefits across recipients.
4. Taxing employer FICA contributions as employee income, paired with phased reductions in benefit-tax inclusion rates.
For each option, we generate annual and cumulative revenue paths, distributional tables by income decile, and marginal effective tax-rate profiles for affected workers. Our results inform debates on aligning benefit taxation with distributional, efficiency, and solvency goals as Social Security nears its projected trust-fund depletion date.

Authors

• Max Ghenis, max@policyengine.org

• Nikhil Woodruff, PolicyEngine

• Pavel Makarchuk, PolicyEngine