The Costly Double Whammy of Aging

There are two primary ways retiring baby boomers will impact revenues.
May 2015
By Frank Shafroth  |  Columnist
Director of the Center for State and Local Government Leadership at George Mason University

For years, we’ve been warned of the profound effect America’s rapidly aging population will have on our services. But there are two areas in particular where an aging population poses the largest threat to the fiscal future of states and localities: health-care costs and tax subsidies.

Let’s start with health-care costs, specifically the increasing costs of providing Medicaid coverage for an expanding population of elderly people in need of long-term care. Baby boomers born between 1946 and 1964 are more likely to live longer and exhaust their resources than previous generations. By 2050, when the youngest boomers will be in their 80s, long-term care for the elderly will devour roughly 3 percent of the U.S. economy, up from 1.3 percent in 2010, according to the Congressional Budget Office.

The growing need for care will have an enormous impact on states and an even greater impact on counties. In 21 states, counties are required to help finance the nonfederal share of Medicaid. In 32 states, they are mandated to provide health care for low-income, uninsured or underinsured residents. To date, there are 960 county hospitals and 676 county nursing homes to serve Medicaid beneficiaries. Those numbers will hardly suffice for tomorrow.

Counties already spend almost $70 billion a year on health-care services -- a fiscal burden that is certain to rise since Medicaid serves as the safety net for the elderly in nursing homes (where a private room can cost a whopping $87,000 a year). It might well be that we should look to Michigan as a governance model: The state is unique in that county-owned nursing homes are in a separate class from for-profit and nonprofit nursing homes. That separate class is the recipient of special funding, which is derived by counties contributing a maintenance of effort (MOE) payment to the state. The state, in turn, uses that contribution to get additional federal matching dollars to serve the Medicaid population and bolster the safety net for those in need of a nursing home.

But just as states and localities gear up to confront this unprecedented health-care challenge, the siren song of tax-free retirement income is warbling through the states. As it is, almost every state levying an income tax allows some form of an exemption or credit for its over 65 citizens. Even as there is an increasing demand for transportation and other public services for the elderly, there is a new wave of interest in expanding tax breaks for retirees.

In Rhode Island and Maryland, measures have been introduced this year to exempt retirement income, including Social Security and private pension benefits, from state taxation. In Maryland, for instance, Gov. Larry Hogan wanted to phase out the income tax on veterans’ pensions -- a proposal he described as just the first step toward eliminating taxes on everyone’s retirement income.

Over the past 40 years, many states have changed the way they tax retirement income, often by enacting full or partial exemptions for pension checks. The hope is to stem the tide of retiree moves to tax-friendlier states. But there is little evidence that high taxes on pension income drive away seniors. There is, however, increased evidence that not taxing such income equitably benefits the rich at the expense of low- and moderate-income households -- and leaves the fiscal cupboard bare for the unprecedented and looming challenges of an aging demographic.