People in their 60s who keep on working can face extremely high tax rates – much higher than the rates faced by millionaires and billionaires, according to a new study.
“Senior workers earning an average income can easily lose more than half of their earnings to higher taxes and reduced government benefits,” said Boston University economist Laurence Kotlikoff, one of the researchers who produced the study. “In some cases, workers can lose 95 cents out of each dollar they earn.”
Kotlikoff, who is also a Senior Fellow at the Goodman Institute, produced the study with Alan Auerbach, an economist at the University of California at Berkeley and two additional authors. The project was funded by the Sloan Foundation and is based on an analysis of penalties for working that arise from roughly 30 major federal and state tax and transfer programs. The economists also consider how the additional earnings, a part of which will generally be saved, will affect future taxes and transfers. The entire impact is summarized in what is called the worker’s “lifetime marginal net tax rate.”
“Millions of elderly citizens are mentally and physically capable of making major contributions to our economy,” said Kotlikoff. “We are all made worse off when these people are pushed out of the labor market by policies that encourage them to retire.”
The study finds that the Social Security System is one of the most important sources of penalties for working. For example:
- Beyond a certain income level, early retirees from age 62 to 66 lose 50 cents of Social Security benefits for each dollar they earn – a 50 percent tax rate.
- From Jan. 1st in the year in which they turn 66 until their 66th birthday, they lose 33 cents of benefits for each dollar of wages – a 33 percent tax rate.
These taxes are on top of income, payroll and other taxes. Although the government begins adding the benefit reduction back once the worker reaches the normal retirement age, many seniors don’t realize that or don’t understand it.
“If we abolished these ‘earning penalties’ the government would probably be a net winner. Seniors would work more and earn more and the other taxes they pay would more than make up for any short-term revenue loss,” said Kotlikoff.
Another impediment to work is the Social Security benefits tax:
- Beyond a certain threshold, seniors must pay income taxes on 50 cents of Social Security benefits for each dollar they earn – increasing their marginal tax rate by 50 percent.
- If they earn even more income, they will reach a point where they must pay income taxes on 85 cents of Social Security benefits for each dollar they earn – increasing their marginal tax rate by 85 percent.
When the Social Security benefits tax is added to the earnings penalty, the tax rate on moderate-income seniors can actually reach 95 percent.
The Social Security benefits tax also imposes very high rates on savings. For example, for someone in the 15% bracket for ordinary income:
- The Social Security benefits tax can increase the tax rate on pension income and IRA withdrawals from 15% to 27.75%
- It can raise the tax on capital gains and dividend income from zero to 12.75%
- Tax-exempt income can also be taxed at a rate of 12.75%.
“These high marginal tax rates only hit in the middle of the income ladder. They don’t affect the work incentives of the rich or the poor,” said Kotlikoff. “However, the loss of the Earned Income Tax Credit and the potential loss of Medicaid and other entitlement benefits create high marginal tax rates for low-income workers in other ways.”