Breaking Down the Senior Deduction in the One, Big, Beautiful Bill

The House-passed reconciliation bill leaves out Trump’s promise to eliminate taxes on Social Security benefits, opting instead to expand the standard deduction for seniors. 

In this episode, Kyle Hulehan and Erica York are joined by Alex Durante to unpack how the deduction works, who benefits most, and how it compares to repealing Social Security taxes. 

Transcript

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Kyle Hulehan 0:00

Hello and welcome to the Deduction of Tax Foundation podcast. I'm your host, Kyle Houlahan, and we are back today with another episode. We have Erica York here, my co-host, and we are joined by Alex Duranti, senior Economist at the Tax Foundation. And we are once again talking about some stuff that has to do with the one big, beautiful bill. First off, uh, we're gonna start off with Erica here. What is the latest in the news with, with the one big, beautiful bill?

Erica York 0:26

So the bill has passed the house. It's now sitting with the Senate Today, we're recording on Friday, June 13th, and we're expecting the Senate Finance Committee to release part of its changes to to the House Pass. Bill today. And then the reporting indicates they'll, they'll release the rest on Monday, June 16th. Um, as long as all of the legislative text is released in the Senate on June 16th, um, they'll take the next week or so to work through that. Make sure it follows the rules of reconciliation with the Senate parliamentarian. Um, then it can pass the Senate the following week. Then the house will have to agree, or the Senate and the House will have to further compromise on a final version of the legislation. And then it would go to the president's desk. So as long as they meet this Monday, June 16th deadline for all the texts, they could still hit this July 4th deadline for getting the bill enacted. But there are a lot of sticking points, uh, between the House and the Senate. So we'll have to see if they can actually work on that fast timeline or if this pushes out later into the summer or potentially early fall.

Kyle Hulehan 1:34

So one thing we wanna kind of discuss here today, uh, switching gears back to. we wanna talk about, um, is we wanna talk, there's social security versus no tax on social security versus this senior deduction or exemption. And Alex Durante here wrote a great article about this and so let, let's start off with a little bit big picture. Why is on social security benefits such like a recurring flashpoint right now in tax policy debates and what made it a focus during the 2024 election?

Alex Durante 2:08

the president during his campaign had, uh, promised to eliminate, um, the taxation social security benefits. There really wasn't, I would say, necessarily a great, um, policy justification or policy rationale offered for doing this. I mean, if you, if you read. Um, some, some of what was written at the time, I mean, a lot of it was just focused on just providing additional relief, uh, to seniors. Um, because they had experienced, um, some cost of living increases, uh, due due to inflation. Um, of course, they, they were not the only ones that, that experienced those cost of living increases. But, um, not, not nonetheless, the president, um, Cho chose. To target them specifically for relief. And, you know, as seniors are, um, you know, a, a, a key voting constituency as well. I think there were also some political reasons, uh, uh, for doing so.

Erica York 2:59

So the house has now passed the one big beautiful Bill Act, but they didn't include Trump's promise to eliminate taxes on social security benefits. Instead, they did expand something that's known as the senior deduction. Can you walk us through how they expanded that? How it works and who it's aimed at helping.

Alex Durante 3:19

I think one of the reasons that we didn't see, the no tax on social security benefits in the bills because it would've been, um, very, very expensive, to, to implement that. Um, our, our estimate put the cost at about $1.6 trillion, uh, over 10 years. Um, the. Additional senior deduction, uh, would cost substantially less than that. Um, in part because it is only scheduled to be in effect from 2025 through 2028. Um, but if it were to extend through the whole decade, it would be between about 200 billion and $300 billion, um, over 10 years. So it comes in, it's substantially less Now. The way that that provision is going to work is right now in the, the current tax code. Um, there actually is already. an additional standard deduction for seniors. married filers, uh, may claim, um, may deduct, uh, $1,600 from their taxable income. And then for unmarried filers, um, the bonus is, uh, the additional standard deduction is a little bit more generous and they can deduct, um, $2,000. The proposal on the house bill is to add a, an additional $4,000 bonus, um, per individual. And then also make that available to taxpayers, uh, that, that itemize, uh, their deductions. it's a bit different, um, because it would not, um, the, the, the, the specific provision, um, would apply to all, um, income that's earned, um, by these recipients, not necessarily just social security income.

Kyle Hulehan 4:54

So with Tax Foundation's modeling it, it shows that the senior deduction gives a, a larger relative benefit to lower and middle income households while Social Security tax repeal, uh, favors high income seniors. Why is that

Alex Durante 5:10

So in some sense by design, um, the additional senior deduction, um. Would not give a lot of benefits to high income taxpayers because it is scheduled, uh, to phase out at around $150,000, um, for joint filers. But, um, if you compare it to um, uh, the Social Security benefit taxation, um, up to 85%, um, of those benefits are taxable. And, um, and there are a lot of, um. Upper middle come earners, um, that have a lot of social security income. Um, and for that reason, they would be the ones that would be betting, benefiting, um, substantially from that relative, um, to this, uh, particular additional senior deduction, which is limited. I. Um, sort of by design to those, uh, lower and middle income taxpayers. But, um, even if you just look, um, near the bottom to quintile, so this is near the bottom of the income distribution. Um, under current law, uh, if your, if you have, uh, what's called combined income, uh, under. Uh, $32,000. So that includes your, um, gross adjusted income plus any, uh, tax exempt interest income, and then plus half of your social security benefits. If that income is below $32,000, you don't face any taxation, um, on your social security benefits. Uh, so when you compare that, um, to the, the additional standard, um, deduction, if they have, um. Other sources of income, they're going to be getting, um, relief from, from that, from that provision. Whereas, whereas they, if, if, um, taxation, social security benefits was completely eliminated, they would not, um, be seeing really many additional benefits from that because they might already be below the, that income threshold.

Erica York 7:02

so just to sum, sum that up to make sure I'm, I'm getting at like, taxation of Social security benefits is primarily something that affects like middle to upper, middle to high income seniors. Um, if you're really low income, your social security benefits are not being taxed under current law

Alex Durante 7:18

yes,

Erica York 7:18

versus this bonus deduction that everybody who's low middle income gets, and then it phases out for, for higher income. So it kind of just is like a, a reverse of the pattern of who who's gonna benefit.

Alex Durante 7:30

Yes, that's right.

Erica York 7:31

Got it. Um, another big difference between the no tax on Social Security versus this bonus, um, standard deduction amount is how it will affect the Social Security Trust funds. Can you walk us through like how the taxation of Social Security benefits fits into financing for Social Security and if they had gone with this plan to eliminate taxes on those benefits, what would happen to to that revenue?

Alex Durante 7:59

Right. So we're gonna have to go, I'm gonna have to give a bit of a, a history lesson here of how, of how we got to this point. so back in 1983, um, the, the, the Social Security Trust Fund was imperiled and there were several reforms, um, that, that were. Passed, um, to ensure that there wouldn't be benefit cuts. Um, one of these was introducing the taxation of social security benefits and what they decide at the time was that, um. um, above, if you had combined income above $32,000, um, half of your Social Security benefits, um, would be taxed under our ordinary income rates. Then in 1990, and then I should say that, that that money would specifically be allocated to the Social Security Trust Fund. Um, then in 1993, um, there was another update, um, to this provision. Where they decided to for, for incomes. Um, so for incomes that were between $32,000 dollars and $44,000, you would still be faced, uh, half of your benefits would, would still be subject to taxation. But then above those thresholds, above $44,000, um, an additional 35% of your social security benefits, um, would be subject to income taxation. So bringing that total. To 85% and that additional 35% would be allocated to the Medicare trust fund. so, so the issue is, you could see, so, so really the, the, the big difference you could see between the, the two proposals here is that, um, if the president had, um, fulfilled exactly what he had promised during his campaign and exempted all social security benefits from taxation, um. Both of the revenues, uh, the revenues going to both the social security, um, trust fund and the Medicare hospital, uh, trust fund, um, would, would be, would, would decline. And the implications of this are for social security, um, that would accelerate the insolvency of the trust fund by about two years. And then for Medicare, that would. So it would actually go, so it would be scheduled to expire in 2033 versus 2035. And then for Medicare, it would actually accelerate the depletion of that trust fund by six years, from 2036 to 2030. Um, so, so the fiscal implications of doing that would've been quite calamitous. And that's possibly also, um, ano another reason why the president. Chose to do, to give more, um, limited, limited relief to seniors, although I won't pretend that, uh, you know, really anyone in Congress, even the current administration cares about, about replenishing, uh, you know, the, the, the trust funds. Uh, but, but nonetheless, I think it just would've been, uh, perhaps politically, uh, untenable at that point.

Kyle Hulehan 10:52

So, wait, I, I need to hop in right here. I, I know that I work at the tax foundation. I'm not an expert like you guys, but am I right to be confused about what you just said? 'cause that sounded very confusing. Like, we're gonna tax 35% of this part in this area and it, and how they're, they're doing. The trust fund seems very wonky or confusing, at least to me.

Alex Durante 11:11

So the way that they arrived at this number is not as, as arbitrary as it may sound. So in 1993, uh, the actuaries, um. Tried to calculate the present value of tax contributions to Social Security, being that they were trying to calculate how much is that future stream of Social Security benefits, uh, worth to you today. And what they found was that the present value of those tax contributions to social security. equal to less than 15% of those lifetime benefits. Um, which means that up to 85% of those benefits could be taxed, um, without risking some kind of double taxation. And, and this is actually important because you, you kind of want to maintain, um, some kind of horizontal equity across all of the types of saving, um, programs that we have in the us. So obviously, um, you know, we have either, um. You know, four 401k style treatment where you can put, um, your income into. Tax preferred accounts. And then when you collect your distributions, you pay tax on that. Or you can have Roth style treatment where you pay the taxes upfront and then deposit, um, the those, um, that income into, into an account. And then when you withdraw from that account, um, you don't pay any taxes on that additional income. So the idea with, uh, taxing. The social security benefits is to just sort of bring it in line, um, with these, with these other forms of savings. Otherwise, if we didn't tax, um, the, the benefits, um, then social security income, um, would be, would be favored, uh, relative to other types of income, uh, in our tax code.

Erica York 12:54

Yeah, I think that's like the, the perfect key. Um, it, it sounds super complicated and there are different income levels at which the different percentages kick in, so that part's confusing. But the whole idea is let's treat social security benefits the same way that we treat the other types of retirement income you get, whether that's through a Roth or a traditional style account. It's just kind of trying to make everything the same.

Alex Durante 13:17

Right.

Kyle Hulehan 13:18

Okay. That, that makes sense. I, I understand that. I appreciate that. Uh, so. Getting back to, you know, these two policies, kind of like juxtaposing these, neither policy seems to generate much economic growth and both add to the deficit, you know? So what should lawmakers be weighing when they're deciding these types of targeted tax cuts, and is there a smarter way to provide relief to seniors without undermining the long term fiscal?

Alex Durante 13:44

I think one thing that would be very sensible, um, so, so what, what might surprise you here is that those thresholds I've been mentioning, you might, if you might recall, I said, um. If you have combined income, um, below, uh, $32,000, you pay no tax, um, on your social security benefits. That threshold has been in place since 1993, so that, that particular threshold is not adjusted for inflation, um, which means that, um, more. Um, seniors are, are being exposed, um, to the taxation of benefits then would be the case if, if that threshold was inflation adjusted. And I think that would be a sensible thing to do because since, um, 1981, um, we, you know, we, we, we inflation adjust many facets, um, of, of our, of our tax code, um, to protect. Um, taxpayers from falling into those higher brackets and then facing a higher tax burden, uh, as a result. So I think a sensible thing to do that would be consistent, um, with the rest of our tax code and would, and would provide relief to seniors, um, would be to index, um, those, those threats, those, uh, particular thresholds, uh, for inflation.

Kyle Hulehan 14:55

So is there way that we can see more economic growth here. Do you feel like there's a more pro-growth option in all of this?

Alex Durante 15:02

The reform I just suggested. I, I, I mean, I think from that perspective, um, it's more, it's more important, um, to have that inflation adjustment, um, to make it consistent. Um, with, with the rest of the tax code, um, would it necessarily be the most growth enhancing policy that we could enact? Um, probably not. And, and I, and I think, you know, part of the reason for this is that, I mean, if you were trying to design, um, a particular kind of tax cut to really increase growth, you know, you maybe target, um, your tax cut, um, towards younger workers or workers that in, in their, their peak early years, and that would be very responsive. Um. To, to a change in their marginal tax rates. Um, you know, obviously, um, seniors, you know, they, they, they're, they're, they're working less, they're close, um, to exiting the labor force. So a lot of this, um, is just providing, um, just sort of, uh, just, it's just more of like just a straight tax relief, which is not necessarily, um, a bad thing to do. And I, and I gave a reason why I think it would be good to, to do it here. Um, but, but really if, if this is, if we were trying to do, um, you know, growth enhancing. Um, tax policies, I, I, I think we would have to look elsewhere in, in our tax code.

Kyle Hulehan 16:16

Yeah. And, and I think that makes sense. And I feel like when it comes to economic growth, you know, there's a balance to all of this. You know, not every policy you're gonna do is going to, like, it might help people and that'll be a good thing. And it might not boom, the economy, but, but that can be okay too. Uh. It just, just depends on the goal you're trying to accomplish, you know? Um, but before we sign off, I just wanna let everyone know if you have any burning questions, you can send them our way. You can drop a comment on YouTube as many of you have done. You can always email us at podcast@taxfoundation.org, or you can slide into the dms on Twitter at the deduction pod. Thank you for listening.