What Social Security cuts could mean

  • Article by: STEPHEN OHLEMACHER , Associated Press
  • Updated: July 7, 2011 - 8:42 PM

An overhaul, if agreed to, could mean higher income taxes for many families.

WASHINGTON - Once considered untouchable, Social Security is now in play in the debt-ceiling negotiations. And that could mean higher income taxes for many U.S. families in addition to shaved benefits for tens of millions of retirees as they age.

Social Security became part of the private discussions between President Obama and Republican House Speaker John Boehner on coming up with "something big" for reducing deficits by $2 trillion to $4 trillion over the next decade. White House officials said Thursday that could include a new inflation measure for Social Security that, through a combination of reduced benefits and higher taxes, could produce federal savings close to $200 billion.

The proposal would represent a reversal for Obama. In contrast to his pledge to target tax increases at the wealthy, high-income families would largely be spared from tax increases that would result from changing the way inflation is measured. But it remains to be seen whether Democrats would agree to a change.

Adopting a new inflation measure would allow policymakers to cut benefits and increase taxes in a way that might not be readily apparent to most Americans. The inflation measure being considered is called the Chained Consumer Price Index. On average, the measure shows a lower level of inflation than the CPI.

A Chained CPI assumes that as prices increase, consumers buy lower cost alternatives, reducing the amount of inflation they experience. For example, if the price of beef increases while the price of pork does not, people will buy more pork.

How benefits could change

The measure, if adopted, would have a wide-ranging effect on taxes and government benefits, and those changes would grow over time. The change would mean smaller annual increases in Social Security payments, government pensions and veterans' benefits. Current payments would not be affected, but recipients would get smaller increases in the future.

Overall, the proposal would cut Social Security benefits by $112 billion over the next decade, said the nonpartisan Congressional Budget Office. It would cut government pensions and veterans' benefits by $24 billion over the same time period if adopted for them as well.

In most years, Social Security payments are increased based on a measure of inflation called the Consumer Price Index for Urban Wage Earners and Clerical Workers. If Social Security adopted the new measure, annual increases would be 0.3 percent smaller, according the program's actuaries.

That could be a tough hit for seniors who have gone two years without a cost-of-living adjustment and are projected to get such a small one next year that it will probably be wiped out by higher Medicare Part B premiums for most recipients.

As the possible cuts are phased in, a typical 65-year-old who started receiving Social Security benefits at age 62 would get an annual reduction of about $130, Social Security actuaries said. By the time that retiree reached 75, the annual cut would be $560. At 85, the cut would be $984 a year. Average Social Security benefits are about $1,100 a month, or about $13,000 a year.

How it could affect taxpayers

If applied more broadly to the tax code, the new inflation measure could hit taxpayers at every income level, raising about $60 billion over the next decade for the government, said the nonpartisan Joint Committee on Taxation. It would limit increases in the standard deduction and personal exemption that most claim. Income thresholds for the child credit and the Earned Income Tax Credit could be affected, and contributions to IRAs could be limited.

Adopting the Chained CPI would mean smaller adjustments to the tax brackets, leading to higher taxes for people at just about every income level. Low-wage workers would see the biggest increases, while high-income taxpayers would see only small changes. That's because the wealthiest taxpayers already pay taxes at the highest marginal rate, currently 35 percent.

For example, by 2021, taxpayers making $10,000 to $20,000 would see a 14.5 percent increase in their income taxes with a Chained CPI, the Joint Committee on Taxation said. Taxpayers making more than $500,000 would get a tax increase of 0.3 percent, while those making more than $1 million would get a tax increase of 0.1 percent.

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