Social Security Reform, Part II

21 Mar 2024 | John Goodman, What's New

Seniors in their 60s are penalized for working if they receive Social Security benefits. Getty Images


In a previous post, I described how the Social Security Administration abuses the elderly by giving them bad advice on how to claim benefits and by demanding repayment for mistakes the government made – sometimes decades ago.

Correcting those abuses needs to be part of any reform of the system. There are also other problems that need correcting.

The Double Taxation of Senior Savings

The “Social Security benefits tax” is a misnomer. If a senior has only Social Security income, there is no tax at all. The tax on Social Security earnings only applies if there is other income. That means that seniors on Social Security face double taxation. They must pay the ordinary income taxes that others pay, such as the tax on their IRA withdrawals, and then pay an additional tax just because they are on Social Security.

  • Seniors in the 15% income tax bracket, for example, can face a tax rate of 27.8% on pension income, IRA withdrawals and 401(k) withdrawals if they are on Social Security.
  • Seniors who would ordinarily pay no taxes on capital gains and dividends (because of their low incomes) can be forced to pay a 12.8% tax on that income if they are on Social Security.

There may be an argument for taxing some portion of Social Security benefits as ordinary income. But there is no good argument for double-taxing savings.

Forcing Seniors to Dissave

One way seniors might avoid the double taxation of their savings is to avoid making withdrawals – leaving the funds until they are really needed, or maybe passing the assets on to their children. But beginning at age 72, federal law requires mandatory withdrawals from IRAs and other tax-favored accounts – which are then subject to punitive taxation.

In a country where there is too little saving, too much borrowing and too much debt, anti-savings measures like these make no economic sense.

Confiscatory Taxes on Wage Income

The Social Security earnings limit for people who have not yet reached the full retirement age is $22,320 in 2024. Above that limit, beneficiaries lose $1 in benefits for every $2 of earnings. That’s a 50 percent tax rate. During the year of their full retirement age, they lose $1 in benefits for every $3 of earnings above $59,520 up to the month of their full retirement. That’s a 33 percent tax rate. When this tax on earnings is added to income, payroll, and Social Security benefit taxes, middle-income seniors can face a marginal tax rate greater than 90 percent.

The Social Security earnings penalty has undoubtedly caused millions of seniors to reduce their working hours or stay out of the labor market altogether. But here is something very few seniors know:

  • Once seniors reach the full retirement age, Social Security increases their monthly benefit for the rest of their lives – to make up for the earnings penalty they were subjected to.
  • In other words, the government taxes senior workers in one time period and then turns around and gives the money back in later time periods.
  • But because they don’t know about the give-back, most seniors think the earnings penalty is lost forever.
  • The reason they don’t know any of this is because Social Security doesn’t explain it to them.

Taxation by Inflation

Although Social Security benefits are indexed for inflation, the tax on those benefits is not. This means every Social Security recipient pays higher taxes when there is inflation – even though they may have no increase in real income. When the benefit tax was first imposed, it hit only 1 or 2 percent of retirees. But because it wasn’t indexed, we are now at a point where more than half of all retirees are paying it.

Treasury Inflation Indexed Securities, or TIPS bonds, work like this: if there is 6% inflation, you get an additional 6% interest payment. Yet even though the extra interest keeps you whole (full protection from inflation), you still have to pay taxes on it.

The value of pension income and IRA withdrawals is also diminished by inflation.


Here are some easy-to-implement reforms:

  • Give Social Security personnel and prospective beneficiaries access to an online calculator to avoid mistakes and make informed judgments about claiming benefits. (Goodman Institute Senior Fellow Laurence Kotlikoff already has a private calculator that does this for private subscribers.)
  • Allow partial benefit claims, so that cash-constrained seniors can claim some Social Security income early, and allow the remainder to grow.
  • Establish a one-year statute of limitations on Social Security clawback claims.
  • Allow beneficiaries to work without losing Social Security benefits.
  • End the practice of taxation by inflation – by inflation- indexing all retirement-income taxation, including indexing the Social Security benefits tax.
  • Eliminate the Social Security benefits tax and make benefits part of ordinary taxable income for future retirees.
  • Eliminate mandatory withdrawals from savings accounts.

A Note on Funding the Reforms

In the short run, abolishing the earnings penalty would involve a redistribution of funds from taxpayers to senior workers – especially low- and moderate-income seniors. (High-income workers are not affected by the earnings penalty – at least at the margin – because their entire benefit has already been taxed away or, more likely, they are delaying “retirement.”) However, evidence suggests that abolishing the earnings penalty would eventually pay for itself because when seniors work and earn wages, they will be paying income and payroll taxes.

Implementing an accurate calculator would also pay for itself since it would reduce the need for human personnel. The savings might even cover the cost of restricting clawbacks.

The way federal budgeting works, Congress only looks at a ten-year window. Suppose as a result of our reforms, the average senior puts off claiming benefits for two more years. That would produce an enormous budgetary savings for the federal government in the budget window. That should be enough to pay for indexing the Social Security benefit tax and other taxes on private retirement income.

In the long run (beyond the ten-year window), the government will be paying larger Social Security benefits to seniors than it otherwise would. We expect this will require a substantial amount of additional redistributing from taxpayers to retirees – relative to the status quo.

However, since this is a long-run problem, it gives us time to consider long-run solutions to Social Security’s far-term financing problems – including raising the retirement age, making benefits less generous for high-income workers and even implementing private Social Security accounts.


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John C. Goodman is President of the Goodman Institute and Senior Fellow at The Independent Institute. His books include the soon-to-be-published updated edition of Priceless: Curing the Healthcare Crisis, the widely acclaimed A Better Choice: Healthcare Solutions for America, and New Way to Care: Social Protections that Put Families First. The Wall Street Journal and National Journal, among other media, have called him the “Father of Health Savings Accounts.”


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