Many retirees and those nearing retirement may be cheering for President Donald Trump’s proposal to eliminate all income taxes on Social Security benefits. But what seems like a good idea at first sight could have multiple downsides at both the individual and macroeconomic levels, in the short run as well as over the long run, according to a new brief by the Penn Wharton Budget Model (PWBM), a nonpartisan think tank.

The PWBM analysis assumed the full removal of social security benefits taxation starting in 2025 and permanently. PWBM faculty director Kent Smetters directed the analysis for the brief, and senior director Felix Reichling produced it along with PWBM experts Jon Huntley, Ed Murphy, Brendan Novak, and Sophie Shin. In early February, a bill to eliminate those levies — the Senior Citizens Tax Elimination Act — was reintroduced in the House, CNBC reported. PWBM included the same provision, with a start date of 2026, in its recent analysis of the House Budget Reconciliation framework.

Impact on Household Savings

One of the biggest consequences of the proposed policy is a reduction in savings among both retirees and working-age households, the brief stated. “If I know I’m going to get larger benefits in retirement, I don’t have to save as much myself for retirement, and I also don’t necessarily have to work as long [as one might otherwise],” Smetters said on the Wharton Business Daily podcast. (Listen to the interview.)

Under the policy, households will have increased after-tax Social Security benefits, which will embolden them to lower their savings targets. At the same time, retirees and those nearing retirement will increase their consumption (the brief estimated that at 0.6% higher over the next 10 years, or by 2034). By 2054, households will have fully adjusted their savings behavior, and consumption is projected to be 0.1% lower in 2054 than it would be under the baseline estimates, the brief stated.

A Steep Price Tag

The campaign promise for the tax exemption missed one bit of detail: how it will be funded. “It’s certainly a popular idea, whenever you tell people they can keep more of their money, but ultimately someone has to pay for it,” said Smetters, who is also a Wharton professor of business economics and public policy. “Right now, the idea is not funded in any way.”

“It’s certainly a popular idea, whenever you tell people they can keep more of their money, but ultimately someone has to pay for it.”— Kent Smetters

Without a funding source, the proposal will cause a chain of big-picture outcomes, according to the PWBM brief:

  • Federal tax revenues will fall by nearly $1.5 trillion over 10 years, starting from $60 billion in 2025 and increasing to $187 billion in 2034.
  • With that, federal debt will be higher than current levels by 3.3% in 2034, and by 7% over 30 years.
  • The lower savings and higher debt will reduce the stock of productive capital by about 4% over the next 30 years.
  • The smaller capital stock will hurt wages, which will fall 0.4% by 2034 and 1.8% by 2054.
  • The combined effect of reduced capital and labor lowers GDP by 2.1% in 2054.

“This provision alone will reduce the size of the economy, or GDP, by about 2% relative to where it otherwise would have been in 30 years,” Smetters said. “So, as fiscal policies go, it’s a pretty big loss.”

Who Gains, Who Loses

It’s not easy to figure out precisely who gains and by how much from a tax exemption on social security payments. That is because of a “convoluted” system where social security benefits are combined with a beneficiary’s other income but not indexed for inflation, and rates that change by income slabs, Smetters noted. (Individuals with combined income of between $25,000 and $34,000 are taxed on up to 50% of their benefits, while those with combined income above $34,000 are taxed on up to 85% of their benefits, according to the brief.)

Notwithstanding that complex math, “the real beneficiaries of this tend to be higher-income individuals, given that lower- and middle-income class people often do not pay these taxes to begin with,” Smetters said.

Using a “dynamic distributional analysis” that considers households across the income and age distribution, including the unborn, the brief narrowed down on the impacts of the tax exemption over the entire lifetime of social security beneficiaries. For example, a person aged 60 at the time of the policy change and with a gross income in the highest income group receives $43,600 of value. At the other end of the spectrum, a 30-year-old person in the lowest income group loses the equivalent of $3,400.

“This provision alone will reduce the size of the economy, or GDP, by about 2% relative to where it otherwise would have been in 30 years. So, as fiscal policies go, it’s a pretty big loss.”— Kent Smetters

According to the brief, more than 60% of currently living households and over 95% of retirees would benefit from the tax exemption. However, all future generations would be worse off, it stated. “The longer households are exposed to the policy and the further in the future they are born, the greater their welfare losses.” Unborn households — those born 20 years in the future — face the largest losses of between $11,700 and $22,000, it stated.

The brief explained why all of that could become reality: “The policy reduces incentives to save for retirement, increases federal debt, and does not encourage higher labor supply. Consequently, capital and wages decline over time, leading to welfare losses.”

In contrast, those who are closer to retirement at the time of the policy change will see welfare gains, because “the policy’s negative effects are not yet substantial enough to outweigh its benefits,” the brief stated.

Those nearing retirement have already saved for retirement, and with the tax exemption, they will have little or no incentive to work longer or save harder in their pre-retirement years, Smetters said. Those outcomes will be visible across income groups for also younger workers who are yet to reach retirement age.

Smetters explained why low-income households would be worse off with this provision. While they don’t benefit from a social security tax exemption because their incomes are too low to attract taxes, they will get whacked by its downside effects. “They’re going to suffer from the macroeconomic consequences in terms of lower wages, simply because you’re going to have less capital that’s built up in the economy, a smaller economy, and lower wages,” he said.

Above all else, Social Security’s coffers will take a direct hit from the tax exemption. Currently, social security tax revenue is deposited in the Social Security Trust Fund. Eliminating taxes on benefits will accelerate the depletion of the Social Security Trust Fund, advancing the year when benefits will be pruned from 2034 to 2032. According to the 2024 report of the Social Security trust fund, its reserves will become depleted in 2033, after which its income would be sufficient to pay only 79% of the benefits.

“It will go in the opposite direction of trying to create solvency in Social Security by taking money away from the Social Security system,” Smetters said.