Who Will Cover the Costs of an Aging America?

Demographic change and tax policies that favor the elderly mean an ever-widening fiscal gap for state and local governments.
by | January 16, 2014

As the nation's population not only ages but the aging also live longer than any previous generation, there will be increasingly serious state and local taxing and revenue consequences. Within four years, seniors are projected to control 70 percent of the nation's disposable income and comprise as much as half the population. This demographic trend heralds a growing fiscal gap between the cost of government services to an aging America and reduced revenues, a gap exacerbated by two unsustainable trends: retirement-benefit liabilities and rising health care costs.

The demographic reality is that we soon will see a fairly dramatic drop in the proportion of workers in the population and the taxes they pay, along with a commensurate increase in the number of people who depend on government at all levels for support. Thus, unsurprisingly, the Government Accountability Office (GAO) has a foreboding outlook for state and local government budgets, forecasting an ever-widening gap between projected revenues and expenses for decades to come. GAO estimates that state and local governments would need to either raise taxes or reduce expenditures by 14.2 percent between this year and 2060 to eliminate that gap.

Consequently, even as states and local governments recovering from the Great Recession face short-term pension and revenue hurdles, these shortfalls pale to what is coming. GAO cites rising health costs as the primary driver of the sector's long-term fiscal challenges. Medicaid expenditures, along with health-insurance costs for public employees and retirees, are expected to rise sharply. GAO projects state and local governments' total health-related costs to climb from the current 3.8 percent of GDP to 7.2 percent by 2060.

As we enter an era when boomers and seniors outnumber the remaining workforce, we may need to reexamine the common practice of granting state and local tax breaks for seniors. Out of the 41 states with personal income taxes, 37 have some type of exemption for retirement income. In addition, 27 states and the District of Columbia exempt all Social Security benefits from income taxes. (A 28th, state, Iowa, will phase out its tax on Social Security benefits by the end of this year.) The remaining states with personal income taxes include some portion of Social Security benefits in taxable income. Seventeen states exempt military pensions from income taxes entirely, while many other states exempt some portion of military pension income. Ten states go the full gamut: They exclude all federal, state, and local pension income from taxation.

State income-tax exclusions for private pension income, however, are not as generous as those for Social Security and public pensions. Twelve states and the District of Columbia fully tax private pensions, while Alabama, Hawaii and Illinois exempt most retirement income and Mississippi and Pennsylvania exempt all retirement income, including 401(k) and IRA distributions. Four states -- Minnesota, Nebraska, Rhode Island and Vermont -- allow no exclusions for pension and other retirement income.

States are not alone in this oncoming day of fiscal reckoning: Many cities and counties offer a senior or elderly property-tax exemption, with the most common being a reduction in the equalized valuation of property so that, in essence, the property owner pays taxes on a discounted value. Some cities and counties "freeze" the assessed property valuation for seniors, thus allowing the property owner to pay property taxes each year based on a previous, lower valuation, while others offer property-tax deferral programs. Cities and counties all have their own terms to qualify for senior or elderly exemptions, but the age of 60 appears to be a common trigger point.

The consequences of these tax policies already have been playing out. The director of one local-government agency providing services to the aging wrote that her department had not received any additional funding in over seven years, a time during which the qualifying population almost doubled. Thirty years ago, she wrote, "there were 5,000 older adults in the county, and we had two senior centers. We now have almost 50,000 older adults and still have two senior centers. The population we serve is changing. We used to serve one generation in a senior center, now we can have three. Different generations require different programming."

A lot of people, she added, think that Medicare pays for the kinds of services her agency provides. It doesn't. Services like these are paid for primarily through state and local revenues. As an ever-increasing percentage of older Americans will require more state and local services but pay less in taxes -- even as they become a majority of voters -- a day of reckoning is coming.

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Frank Shafroth

Frank Shafroth is the director of the Center for State and Local Government Leadership at George Mason University.

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VOICES is curated by the Governing Institute, which seeks out practitioners and observers whose perspective and insight add to the public conversation about state and local government. For more information or to submit an article to be considered for publication, please contact editor John Martin.

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