TAXATION OF OASI BENEFITS

William Larsen

August 13, 2000

Reporting 85% of OASI benefits as income for Income Taxes poses a question quite often. Is it fair? Did not the worker pay federal income tax on the OASI tax over the years? The answer is not as straight forward as it might appear.

The FICA tax which includes the OASI tax is taken out after taxes. This means every worker paid tax on the amount of OASI tax. The question is how much OASI tax have people paid over their working lives? For those prior to 1970, it was extremely small relative to the OASI benefit.

If we were to analyze those who began work in 1950 at age 18, we could evaluate fairly accurately the maximum percent which should be taxed. The problem is complicated by the numerous changes which have taken place in the wage base and the tax itself. However, even these minor variables are easily accounted for on a year by year analysis.

Basis for this calculation is as follows:

Retirement age 65

Lives to age 83 (average life expectancy of males and females combined at age 65 is 17.82 years)

Wages increase each year at the rate of change in the Average United States Wage Growth

The OASI benefit calculated uses the actual Social Security OASI benefit formula

SUMMARY

It is clear the employee's share of OASI taxes paid over a working career and living to age 83 will result in a minimum gain of 86% on taxes paid. This means an OASI benefit should be taxed at a minimum of 86%. Since congress is subjecting 85% of OASI benefits to taxation, it appears to be fair for the high wage earners. For the average wage earner, the gain is over 90%.

If you were self employed, you paid both employer and employee OASI taxes. The OASI benefit subjected to taxation should then be half the listed amount in the last column. To be fair about the taxation of OASI benefits, taxation should not begin until the worker recouped their initial OASI taxes paid. In this case all retirees born in 1932 would recoup their total OAS tax in less than 3.4 years.

In addition, we know anyone retireed prior to 1997 will have paid in even less OASI taxes and recieved equivelent OASI benefits, the amount of gain on OASI taxes paid is actually increases with each preceeding year. In other words, the amount to subject to taxation should increase for these retirees.

There are several ways to keep up with the taxation amount. One would be to have Social Security issue a statement of OASI taxes paid and OASI benefits paid. They could easily calculate the OASI benefit amount to be reported as income on the federal income tax return.

Another way would be to begin subjecting all OASI benefits to those 70 years an older to 100% taxation. In this way, paper work is kept to a minimum and all workers would not pay taxes on previous OASI taxes paid.

Does taxing OASI benefits pose a particular burden to retirees? No, the taxation of OASI benefits is the same thing as taxing capital gains, interest and dividends. Currenlty if you do not make enough to pay federal income taxes, then you most likely would not be affected. Those who currenlty pay federal income taxes, but do not have sufficient income to have any OASI benefits taxed would be the only group who would see their taxes increase.

The outlook for future retirees is bleak. If OASI is only capable of paying 60% of projected benefits, then 90% of all retirees after 2037 will actually pay more in OASI taxes than they will receive in benefits. At this point, no benefits hopefully would be taxable. Those who would actually have a gain would have such low benefits, that few of these would exceed the income threshold to pay any taxes.

YEAR 1997: RETIREES BORN IN 1932 AND OASI TAX PAID
LAST YEARS WAGES	FULL OASI BENEFIT	LIFE TIME WAGES	LIFE TIME OASI WAGES	LIFE TIME OASI TAX	LIFE TIME OASI TAX RATE	LIFE TIME OASI BENEFIT	OASI BENEFIT TO TAX	YEARS TO RECOUP
$9,821	$5,817.73	$186,843.61	$186,843.61	$8,730.99	4.67%	$146,123.07	94.02%	1.50
$10,803	$6,105.79	$205,527.97	$205,527.97	$9,604.09	4.67%	$153,358.25	93.74%	1.57
$11,883	$6,422.65	$226,080.77	$226,080.77	$10,564.50	4.67%	$161,316.95	93.45%	1.64
$13,071	$6,771.21	$248,688.85	$248,688.85	$11,620.95	4.67%	$170,071.52	93.17%	1.72
$14,378	$7,154.62	$273,557.73	$273,557.73	$12,783.05	4.67%	$179,701.55	92.89%	1.79
$15,816	$7,576.37	$300,913.51	$300,913.51	$14,061.35	4.67%	$190,294.57	92.61%	1.86
$17,398	$8,040.29	$331,004.86	$331,004.86	$15,467.49	4.67%	$201,946.91	92.34%	1.92
$19,138	$8,550.61	$364,105.34	$364,105.34	$17,014.24	4.67%	$214,764.47	92.08%	1.99
$21,051	$9,111.96	$400,515.88	$400,515.88	$18,715.66	4.67%	$228,863.79	91.82%	2.05
$23,156	$9,729.44	$440,567.47	$440,567.47	$20,587.23	4.67%	$244,373.05	91.58%	2.12
$25,472	$10,408.67	$484,624.21	$484,624.21	$22,645.95	4.67%	$261,433.22	91.34%	2.18
$28,019	$11,155.83	$533,086.63	$532,701.27	$24,897.54	4.67%	$280,199.42	91.11%	2.23
$30,821	$11,977.70	$586,395.30	$583,517.29	$27,317.98	4.66%	$300,842.24	90.92%	2.28
$33,903	$12,732.03	$645,034.83	$634,842.64	$29,853.34	4.63%	$319,788.70	90.66%	2.34
$37,294	$13,039.62	$709,538.31	$686,929.08	$32,502.90	4.58%	$327,514.30	90.08%	2.49
$41,023	$13,347.28	$780,492.14	$742,361.99	$35,346.42	4.53%	$335,241.81	89.46%	2.65
$45,125	$13,644.25	$858,541.35	$799,646.17	$38,313.45	4.46%	$342,700.87	88.82%	2.81
$49,638	$13,927.89	$944,395.49	$858,670.79	$41,403.80	4.38%	$349,824.89	88.16%	2.97
$54,602	$14,224.67	$1,038,835.04	$921,843.67	$44,726.33	4.31%	$357,279.18	87.48%	3.14
$60,062	$14,499.57	$1,142,718.54	$984,705.39	$48,078.72	4.21%	$364,183.89	86.80%	3.32
$66,068	$14,610.62	$1,256,990.40	$1,014,460.25	$49,683.83	3.95%	$366,973.08	86.46%	3.40
$72,675	$14,610.79	$1,382,689.44	$1,014,500.00	$49,685.93	3.59%	$366,977.36	86.46%	3.40
$79,942	$14,610.79	$1,520,958.38	$1,014,500.00	$49,685.93	3.27%	$366,977.36	86.46%	3.40
$87,937	$14,610.79	$1,673,054.22	$1,014,500.00	$49,685.93	2.97%	$366,977.36	86.46%	3.40