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The Taxing Problem Due to an Aging Population

Why states are in for a financial squeeze as their residents get older


(Reprinted with permission from The Council of State Governments’ Capitol Ideas magazine.)

Why are state fiscal leaders concerned about the aging of the population?

Typically, when we talk with them, the conversation inevitably turns to the cascading cost of health care borne by the states as men and women reach their 70s, 80s and beyond. But, though this is viewed as a policy challenge, at bottom, nobody seems to argue that the phenomenon of an aging population is, at heart, a bad one. As actor Maurice Chevalier said when asked about aging, “consider the alternative.”

If the U.S. population in 2011 had the age composition projected for 2030, the total of states’ tax revenues would have been lower by $8.1 billion.

The population statistics themselves are riveting. According to Census Bureau data, about 14.5 percent of the U.S. population is age 65 or over now, but that number will grow by about a third before 2030. The proportion of seniors varies from state to state. In Georgia, for example, an estimated 11.6 percent of the population is over 65 now, and 15.9 percent will have reached that point in 15 years. In Florida, by contrast, 19.5 percent of the population is over 65 and the number is anticipated to rise to 27.1 percent by 2030.

Older Residents Mean Less State Revenue

But the repercussions of an aging population don’t end with growing expenses.

“I don’t think that people think about the revenue side of aging very often,” said Susan Brower, state demographer in Minnesota.

As people age, they are inclined to earn less, and as a result they bring in less money for states through income taxes. They’re also inclined to spend less, which can decrease sales tax revenue. According to a paper co-authored by Alison Felix, vice president of the Federal Reserve Bank of Kansas City’s Denver Branch, “On average, spending by those younger than 25 and those older than 75 was slightly more than half of that of middle-aged consumers.”

Revenue Streams That Decline With Aging

One interesting wrinkle: As states increasingly turn to sin taxes, they are ever more reliant on revenue streams that decline with aging. As the Centers for Disease Control and Prevention has found, while 20 percent of adults between 25 and 44 smoke cigarettes and 18 percent between 45 and 64 smoke, the portion of cigarette-smoking adults 65 and older drops to 8.5 percent.

According to Felix, the aging of the population reduces both income tax and sales tax revenue per capita in nearly every state.

According to her paper, “The Impact of an Aging U.S. Population on State Tax Revenues,” if the U.S. population in 2011 already had the age composition that is projected for 2030, the total of states’ tax revenues would have been lower by $8.1 billion.

Why the Effect of Aging Doesn’t Show Up for States

Part of the reason this phenomenon tends to go unnoticed is that it’s the accumulation of very gradual year-to-year changes. As Jeff Robinson, senior fiscal analyst with the Iowa Legislative Services Agency said, “States tend to budget out for one or two years and the effect of aging on revenues doesn’t show up. But if you look out years it’s a big issue. … I’ve been concerned about this for a very long time.”

The fact that states don’t tend to do long-term budgeting means that issues like this can easily go unnoticed, no matter how important they may be over the long term. In fact, calculating budgets for more than two years was one of the 10 recommendations we made in a December 2015 paper we wrote for the Volcker Alliance.

When Retirement Income Isn’t Taxed

Of course, it’s not the case that when people retire, they suddenly stop bringing in income. Beyond the cash they get from savings, there’s also a flow of money from Social Security and pensions. But those earnings don’t do the state any good if it doesn’t tax them, and that’s frequently the case.

In fact, the majority of states don’t include full Social Security retirement benefits in calculating taxable wages. Many of the remaining states exempt some portion of that income. Connecticut, for example, uses an earnings test to determine how much of Social Security income should be taxed.

On the pension side, there are a variety of ways in which the states determine how much money should be taxed, according to the National Conference of State Legislatures. Alabama, for example, doesn’t get money from defined benefit plans [traditional pensions], while Hawaii excludes money that comes from defined contribution plans [like 401(k)s]. Pennsylvania is extreme in this instance, and excludes all income from pensions.

Why States Aren’t Pursing Retiree Income

With states in fiscal stress, you might think that going after more retirement income would be one way to help balance the books, but that doesn’t take into account the way politics often works. It takes a lot of political courage to inflame older citizens who tend to vote more often than other age groups relative to their percentage of the population. Nearly 60 percent of citizens over age 65 vote, compared to less than 40 percent of those age 35 to 44.

“The idea of going in that direction doesn’t seem likely to me,” said Robinson, even though a couple of states have done so. “It seems like the situation has the potential of getting worse instead of getting better.”

By Katherine Barrett and Richard Greene
Katherine Barrett and Richard Greene are Council of State Government Senior Fellows and experts on state government. They work with Governing magazine, the Pew Charitable Trusts, the Volcker Alliance, the National Academy of Public Administration and others.

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