Do Income Taxes Affect the Progressivity of Social Security?

Policymakers have designed Social Security to be a progressive retirement program that replaces a larger share of monthly earnings for low- and middle-income workers than for high earners. However, previous research has found that, although the Disability Insurance (DI) component of Social Security is very progressive, the Old-Age and Survivors Insurance (OASI) component may be less progressive than intended. One reason is that high earners tend to live longer than low earners. Since Social Security pays an annuity that lasts throughout retirement, it benefits high earners with greater longevity. Social Security’s progressivity may also be affected by federal income taxes paid by workers and retirees, but research to date has largely ignored this effect. This brief uses data on households from the Health and Retirement Study to examine the interaction between income taxes and Social Security contributions and benefits. The discussion proceeds as follows. The first section describes factors that could affect the progressivity of the OASI component of Social Security. The second section introduces three ways in which the income tax system could impact progressivity: the treatment of employer contributions to Social Security; the Earned Income Tax Credit; and the taxation of Social Security benefits. The third section describes the data and methodology used to analyze households in three birth cohorts and presents the before- and after-tax re­sults for the oldest cohort. The fourth section extends the analysis to the two later cohorts to assess whether the role of taxes changes over time. The conclusion is that the net impact of taxes on progressivity is modest, as large effects from the separate tax provi­sions mainly offset one another. Over time, however, the net impact of taxes appears to be growing more progressive as an increasing number of retirees are required to pay income taxes on their benefits under current law.