While the system is generally indexed for inflation, taxation of Social Security benefits is not
The federal income tax is generally indexed for inflation. Most particularly, the income brackets to which the marginal tax rates apply are increased in line with the “Chained CPI-U.” While the chained CPI-U has risen somewhat less rapidly than the headline CPI-U or the CPI-W used to adjust Social Security benefits, the adjustment will be significant .
While the indexation ensures that workers whose earnings go up by 8% are not harmed by inflation and those whose gains are less than 8% actually see a reduction in their tax burden, such is not the case for retirees. Because the provisions for taxing Social Security benefits are not indexed at all for rising prices, inflation leads to higher taxes for beneficiaries.
Unlike the rest of the federal income tax, the thresholds for calculating Social Security taxes are not indexed for inflation. As a result, if the CPI-W in the third quarter of 2022 exceeds that of the third quarter of 2021 by, say, 9.5%, the 2023 cost-of-living adjustment will force many who currently do not pay taxes on their benefits to include 50% in their calculations and many others who only include 50% to pay taxes on up to 85%. That is, many retirees will see a tax hike.
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