The partisan flame of a Social Security debate has continued unquenched by the recent elections. While this flame has yielded a great deal of smoke, it has provided little illumination. Part of the problem is that all the substantive discussion by the National Commission on Social Security Reform and the other major political players is being carried on behind closed doors. The result is that the public is being denied a clear, focused debate on the broad range of options that can be considered.

One option that does not appear to be receiving serious political consideration is the possibility of changing the tax treatment of Social Security benefits. This option is receiving little attention because the issue is a political lightening rod. Every time the possibility of taxing benefits is raised the hinges are nearly ripped off every door on Capitol Hill. That problem notwithstanding, the Congress should garner at least enough intestinal fortitude to discuss the issue openly. There are several options to consider.

The most extreme would treat all Social Security benefits as regular income. An argument against this approach is that employee payroll taxes are not themselves deductible for purposes of computing income taxes. Thus, while the employer contribution is not taxed, treating all benefits as regular income would amount to double taxation of employee contributions.

This criticism has led to consideration of a second option that would treat only benefits in excess of employee contributions as regular income. This would bring the tax treatment of Social Security benefits into line with tax policy on other retirement programs. Employer pension benefits, for example, are taxed when the benefits exceed employee contributions that were taxed in the year they were earned. This option would mean that somewhere between 80 and 90 percent of all benefits would be treated as regular income.

A third variant would treat only 50 percent of cash benefits as regular income for tax purposes. The argument for this approach is that the employee has already paid taxes on half the contributions that result in the benefit entitlement. This option would still provide a highly favored tax treatment to Social Security benefits, but would have little or no effect on those beneficiaries who rely solely on Social Security for their retirement income. Essentially the same thing would be accomplished by a set of options that would not consider Social Security benefits as regular income until some threshold of total income was reached by the retiree.

There are basically two reasons why the Congress should seriously consider changing the tax status of Social Security benefits:

First, treating benefits as taxable income would be as effective and would have fewer adverse effects on the low-income elderly than the cost-of-living adjustment options now being considered. Taxing 50 percent of benefits would net $56 billion for the trust funds between 1984 and 1989. By comparison, delaying the 1983 COLA by three months would save $23 billion. Completely eliminating it would save $94 billion over the 1984 to 1989 period. Taxing half of benefits then would be almost equivalent to delaying the 1983 COLA by six months, which is rumored to be a considered option. Completely eliminating the COLA increment in 1983 or moving it back three or six months would definitely raise official poverty rates among the elderly primarily dependent on Social Security benefits. Taxing half of benefits, on the other hand, would have no effect on those at or near the poverty line.

Second, significant segments of the elderly population are in a much better economic position than young workers to share the burden of balancing Social Security financing. By examining the March 1980 Current Population Survey conducted by the Bureau of the Census, the potential effects of various Social Security adjustments on the young and older segments of society can be compared.

The young group includes all families with earnings in 1979 where no family member had yet reached age 65. The old group includes all families with one or more persons 65 or over. For purposes of illustration, each group was split into quintiles by per capita family income. While the elderly are known to underreport income to a greater extent than younger individuals on these types of interviews, the results are still instructive. The highest two quintile groupings among the older households had higher per capita incomes than the lowest three groups in the working family category.

Taxing half of benefits would affect primarily the top 40 percent of the elderly in the income distribution. Raising the payroll tax, on the other hand, would impact most heavily on the bottom two-thirds of the work force on the basis of earnings. For many of these workers the payroll tax is already their greatest tax burden. Raising the payroll tax will not only increase that burden on low and moderate income earners even further, but also may threaten their jobs in many instances.

The question that the Congress should consider in its deliberations of various options is: who can most reasonably bear the burden of the alternative adjustments? This question suggests that the Congress should consider taxing benefits as part of the ultimate Social Security financing solution.