Advocates for exempting Social Security benefits from New Mexico income tax contend the tax constitutes double taxation, that the benefits amount to beneficiaries receiving back their own money which has already been taxed. This contention is mostly false.
The federal Social Security Trust Fund, which is essentially a bookkeeping device within the federal treasury, is credited with funds from several sources and pays benefits from those sources. The largest four sources are employee contributions, employer contributions and interest earned on each of these contributions for the period between receipt and the payment of benefits. Of these four sources, only the employee contributions have been taxed. The employer receives a tax deduction for its contributions and, of course, no one is taxed on the interest earned by the government.
The trust fund also regularly receives an annual transfer from the federal treasury equal to the amount of tax paid on Social Security benefits by current beneficiaries. Interest also accumulates on these funds. This transfer is essentially a subsidy of the Social Security Trust Fund by the general funds of the treasury.
In addition, because the sum of these above amounts is insufficient to support the level of benefits paid, occasionally Congress will act to support the fund by increasing the tax on future taxpayers or by making direct transfers into the fund. All these amounts bear interest and are available to pay current beneficiaries. Those beneficiaries have neither contributed them nor been taxed on them.
Finally, long-lived Social Security recipients also benefit from winning a sort of longevity lottery. Their benefits are partially supported by contributions made by or on behalf of workers and other beneficiaries who die early. Of course, the surviving Social Security recipients have not contributed nor have they been taxed on these amounts.
In total, it seems likely that approximately 75% to 85% of the amounts of Social Security benefits paid to the average recipient come from funds on which that recipient was not originally taxed. This is consistent with the existing statutory provision that no beneficiary is taxed on more than 85% of the Social Security benefits received.
While the taxation of Social Security benefits is not an instance of double taxation, New Mexico does impose a clear example of double taxation that harms both New Mexico businesses and consumers. The “pyramiding” of gross receipts tax occurs when businesses must pay gross receipts tax on goods or services that are necessary to produce their final product and then that tax is incorporated into the final price charged to the consumer, the entirety of which is then subject to gross receipts tax.
Recently the Legislature has partially eliminated gross receipts tax pyramiding, but substantial pyramiding remains. If the Legislature is concerned about double taxation, pyramiding is a more appropriate target than Social Security benefits.