Seniors Left Behind in Rush to Cut Taxes

By KATHY M. KRISTOF

May 27, 2001 12 AM PT

TIMES STAFF WRITER

While lawmakers scrambled to provide a massive tax cut for Americans, senior citizens such as Lonell Spencer, a 72-year-old retired machinist who lives in Arcadia, wondered why they’d been left out.

Thanks to a 1993 law that dramatically increased the amount of Social Security benefits subject to taxation, millions of middle-income seniors--people with incomes between $34,000 and $75,000--pay taxes at higher marginal rates than millionaires do.

“This bothers me considerably,” Spencer said. “I had a small inheritance and it was really unbelievable how much it was diminished by the taxation. I know it sounds weird, but this does not affect the wealthy. The only people who are hurt by this are the middle class.”

In fact, federal income taxes can gobble up more than half of any extra income a middle-class senior citizen might earn, said Mark Luscombe, principal tax analyst at CCH Inc., a Riverwoods, Ill.-based publisher of tax information.

Members of Congress and the AARP--formerly known as the American Assn. of Retired Persons--have been working to get the 1993 tax law repealed for years, or at least amended to make it less onerous. But now, despite the prospect of a $1.35 trillion tax cut, the chances for repeal have never seemed more remote.

Bills aimed at reducing the tax on Social Security benefits have been introduced in both the House and Senate, but they have stalled in committee.

Major tax legislation such as President Bush’s tax cut bill is generally an ideal vehicle for eliminating unpopular taxes. But it was impractical to try to dump the tax in this go-round, said David Certner, director of economic issues at the AARP in Washington, because almost anything that would boost the cost of the tax cut would have little chance of surviving the compromises needed to pass the bill.

Sen. Tim Hutchinson (R-Ark.), author of the Senate tax repeal bill, considered proposing an amendment to the Senate version of the Bush tax cut that would have rolled back the tax on Social Security benefits to its pre-1993 level. But that would have cost the federal government some $117 billion over 10 years. Hutchinson opted not to offer his amendment to avoid almost certain political wrangling, said D.J. O’Brien, a spokesman for Hutchinson. The AARP has even taken the repeal attempt off its current legislative agenda.

“What’s happening this year [with tax legislation] is largely driven by the president’s priorities, and [the Social Security tax] was not on his priority list,” Certner said.

But seniors such as Earl Dover, an 84-year-old who lives in Hinsdale, Ill., aren’t willing to let the issue die. Dover, Spencer and others have peppered their elected representatives with letters and phone calls, and they frequently contact reporters to complain about what they argue is a grossly unfair tax.

“I figured with all this surplus money that they’re going to start giving out, they could do something about this,” Dover said of Bush’s tax-cutting plan. “But I am one man in the wilderness. You never hear anything about it.”

Adds Spencer: “[The Social Security tax] was passed as a tax on the rich, but it’s not. It specifically only affects middle-income retirees.”

To understand how this happened, a little background is necessary.

When the Social Security system was created in 1933, benefits weren’t taxed. That changed in 1983 when Congress slapped a tax on up to half of the Social Security payments received by many taxpayers whose overall income--wages, pension payments, Social Security benefits so forth--exceeded $25,000 for singles or $32,000 for married couples filing jointly.

For a couple with an annual income of $35,000 in wages and pensions and $20,000 in Social Security, that translated into a $1,820 tax on their Social Security benefits, based on their marginal tax rate of 28%.

Things got even worse for seniors with passage of the 1993 tax bill, which increased the maximum portion of a person’s Social Security benefits that could be taxed from 50% to 85%. Although the tax was advertised as a levy on “wealthy” recipients, retirees with incomes as low as $34,000 if single or $44,000 if filing jointly were subject to the tax.

Because more of their Social Security benefits were now subject to taxation, the couple in the above example saw the federal income taxes on their benefits rise to $1,928--or $108 more than before.

Worse still, for each $1,000 that the couple’s income increased--say they inherited money or took part-time jobs--they could end up paying more than half of the added income in tax. That’s because the $1,000 would make an additional $850 of their Social Security benefits (85% of $1,000) taxable.

So instead of paying ordinary income tax on $1,000, this couple pays tax on $1,850. In effect, $1,000 in extra income costs them $518 in tax. That’s an effective marginal tax rate of 51.8%, well above the top marginal rate of 39.6% now paid by married couples making more than $288,000 a year.

“It is a form of double-taxation--a heightened form of double taxation,” O’Brien said.

What especially troubles Spencer is that the income thresholds that trigger taxes on Social Security income are not adjusted for inflation. If seniors simply withdraw more from their pensions to keep up with inflation, they get hit harder by the double tax.

Moreover, because of inflation, relatively poorer retirees get sucked into the Social Security tax each year. Fewer than 10% of all retirees paid tax on Social Security income when the 50% tax was first imposed, but roughly 32% of recipients find their benefits taxable today. Some 9 million retirees pay tax on 85% of benefits, O’Brien said.

“Don’t ever listen to people telling you that you’re going to be in a lower tax bracket when you retire,” Spencer said. “I would be in a lower bracket if it wasn’t for Social Security, but because of this tax, I pay more than I ever have.”

If the law isn’t changed, at least to index the income levels to inflation, baby boomers will be forced into the Social Security tax bubble at poverty-level incomes, Spencer said.

Still, it’s tough to eliminate a tax once it’s been implemented, especially one that brings in so much revenue, O’Brien said. Nonetheless, he said, Hutchinson will revive the issue later in the year.

But for now, seniors such as Spencer and Dover will wait and wonder why retirees have been relegated to second-class status when it comes to middle-class tax cuts.

“Baby boomers just don’t understand. Everybody tells them to save, but there’s this Catch 22,” Spencer said. “If you save, you end up paying more tax on your Social Security.”

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at https://www.latimes.com/perfin.

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A Growing Burden

The number of Americans paying tax on their Social Security benefits has soared since the tax was imposed in 1983. The biggest growth came after 1993, when a greater portion of benefits became taxable.

No. of tax returns with taxable Social Security income (in millions)

‘80: 0

‘85: 3.0

‘90: 5.1

‘95: 6.6

‘97: 8.3

‘98*: 9.1

Taxes collected on Social Security benefits (in billions)

‘80: $0

‘85: $9.6

‘90: $19.7

‘95: $45.7