State Senate Republicans recently unveiled their 2020 legislative session tax plan. Its centerpiece is full income-tax exemption for Social Security benefits. Some DFL senators also support a full exemption.
We are retired tax professionals (a former nonpartisan tax staffer for the Minnesota House and a former commissioner of revenue and longtime private tax lawyer). Although both of us would benefit handsomely, we urge the senators to rethink their position. There are better uses for the large cost of this exemption — whether they are other tax cuts or spending.
Minnesota’s tax system needs reform, but expanding the Social Security exemption would only make matters worse. Aside from currying political favor with older voters, there is no good reason for it. Compelling considerations argue against it, while the standard “for” arguments do not hold water.
First and foremost, exempting Social Security violates the most basic tax fairness principle: equal treatment of equals. Two people with the same income should pay the same tax.
Why should retired parents pay less than their working children with the same income? Why should someone whose income comes from taxable Social Security and IRAs pay less than another senior with lower Social Security who works as a Walmart greeter to make ends meet? Posing the question answers it.
Social Security benefits are income, just like wages, interest or dividends. Exempting them results in unfair preferential treatment.
Proponents of full exemption typically respond by asserting that taxing Social Security is double taxation because workers paid income tax on their contributions. Yes, recipients should be allowed to recover their contributions without paying tax again. But guess what, they already do.
Congress addressed that concern by exempting 15% of benefits for all recipients. That parallels the taxation of private and public pensions. Minnesota follows federal law on this, so it has no double taxation either.
But it gets better. Social Security benefits already receive highly preferential tax treatment under federal and Minnesota law. Federal law exempts benefits of lower-income recipients, taxing more benefits as income rises. The 2017 and 2019 Legislatures added a Minnesota subtraction to the federal exemption that Minnesota starts with. About 70% of Social Security benefits are exempt from Minnesota tax, and more than half of recipients with the lowest incomes pay no Minnesota tax on any benefits.
Thus, full exemption would do nothing for the lowest-income half of recipients, while benefiting higher-income recipients. Those who need it least would benefit the most.
Some argue full exemption is necessary to keep well-off seniors from leaving Minnesota. That is nonsense. Many factors affect such decisions (family, friends, community ties, weather, amenities, etc.). Studies that control for these factors find that retirement income tax breaks have no measurable effect on whether seniors move.
Moreover, higher-income seniors, the group most likely to move to reduce their taxes, have a lot of income beyond Social Security benefits. They would derive much benefit from a move to one of the seven states with no income tax. A full Social Security exemption would be meager fare compared with paying no state income tax at all.
Compounding the foolishness of full exemption, seniors have lower poverty rates than the general population. The frosting on the foolishness cake is that seniors are also creating increasing pressure on the spending side of the budget, with growing numbers needing assistance from the state for their care.
If the goal is to help seniors, finding innovative ways to solve the crisis in long-term care is surely more important.
Finally, some argue that because most states exempt Social Security, Minnesota should, too. Only 13 states tax Social Security, and West Virginia is phasing its tax out. The reason is clear: The politics are favorable. Seniors are the most reliable voters — they talk to, write and call legislators — and the superficial case for the exemption sounds appealing.
But that is no reason to blindly follow other states. Minnesotans have long been proud of having a government that works — in part because we don’t make ill-considered decisions based on political considerations. Exempting Social Security may be smart politics, but it’s a dumb policy.
Minnesota needs to pay attention to its tax and spending competitiveness, but this is not the way to do it. To be frank, Minnesota is a high-tax/high-service state. Full exemption would be costly. The Revenue Department estimates it would reduce taxes annually by more than $400 million. As more of the baby boom retires, the tab would grow to more than $600 million for 2027. That would hinder Minnesota governments’ ability to deliver the services Minnesotans expect or to cut taxes in fairer, smarter ways.
We need more efficient taxing and spending. With a labor shortage, one focus should be on making the state more appealing to workers and their families. A well-designed business tax cut to improve productivity would also help. Full exemption of Social Security benefits would not.
This should not be a partisan issue. The two laws that taxed benefits (in 1985 and 1994) were enacted on a bipartisan basis. States that tax Social Security are red (seven), blue (four), and purple (two).
We urge legislators to keep taxing our Social Security and focus their efforts on making our tax and spending policies better for all, including the younger generations on whom the state’s future squarely rests.
And we urge our fellow senior citizens to let their legislators know that they don’t mind paying income tax on their Social Security benefits just as they do on pensions and other income — especially if it helps lawmakers find a way to ease the growing crisis in long-term care that afflicts so many seniors and their families.
Joel Michael is a former research tax analyst for the Minnesota House. John James is an attorney who was Minnesota’s commissioner of revenue from 1987 to 1991 under Gov. Rudy Perpich.