States Urged to Curb Senior Tax Breaks

The cost of income tax breaks for senior citizens — offered in 41 states — could double as a share of the budget in many states as baby boomers retire over the next two decades, a new study predicts.

In 20 years, when one in five Americans will be 65 or older, Kentucky, Mississippi, North Carolina and Pennsylvania will spend more than 7 percent — as much as most states spend on prisons — on senior tax preferences, according to the March 6 report by the Center on Budget and Policy Priorities, an advocacy group for low- and moderate-income people.

This revenue dent will occur just as age-related expenses, including Medicaid and state pensions, are growing, the study warns.

Such findings lead the Center, along with AARP, a leading advocate for the elderly, to argue that states should roll back senior tax preferences — or at least not adopt new ones – because aging boomers don’t all need tax breaks. Baby boomers are wealthier on average than younger people and wealthier than elderly people were decades ago when many of the tax preferences were passed, they argue.

“Being elderly isn’t the same thing as being poor. States should consider whether their tax policies reflect that fact,” said Elizabeth McNichol, author of the report.

Economists, though, contend any state revenue loss from tax preferences for seniors is far outweighed by the value to states of attracting boomer retirees — or keeping ones that already live there. On average, retirees spend more than younger people and pay more taxes, including sales and property taxes. In addition, they require fewer state-funded services and create jobs.

“Florida has no income tax, and they tout that far and wide. If states want to compete for boomer retirees, they need to offer some type of tax incentives,” says Gene Warren, an economist who advises state economic development officials.

In addition to Florida, eight other states — Alaska, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming — have no income tax.

Of the 41 states with an income tax, 27 exempt some Social Security income, the report found. Thirty-one states exempt some pension income, and 37 offer special income-tax deductions or credits based on age. In addition, 25 states provide special property-tax exemptions or credits for the elderly.

The report said the cost of these tax preferences exceeds 3 percent of general funds in at least seven states: Illinois, Kentucky, Michigan, Mississippi, New York, North Carolina and Pennsylvania.

On average, income taxes represent about one-third of state revenues, sales taxes represent one third, and corporate and other taxes make up the balance. Property taxes accrue to local jurisdictions and are used primarily to pay for education.

In the 1970s, when many senior tax preferences were first established, some 25 percent of people over age 65 had fixed incomes below the poverty level. Today, only 10 percent of the elderly are poor, and in the next two decades, the percentage is expected to be even lower.

“Once large numbers of baby boomers start retiring and begin to benefit from these tax breaks, they’ll become not just more expensive, but also more difficult politically to modify,” McNichol said.

AARP agrees. Tax relief is warranted for people who can’t meet their living expenses, but it’s hard to “justify preferential treatment on age grounds alone or on the basis of receiving pension incomes,” says AARP Policy Director John Rother.

Rolling back tax breaks — rarely a politically popular proposition — could be even harder today because “the headline is that state revenue is coming in real strong,” says Scott Pattison, executive director of the National Association of State Budget Officers. “There’s a lot of talk about new tax breaks in this year’s budget sessions,” he said.

But as the senior population grows, it may become harder to justify age-related tax preferences, Pattison said. “How do you tell a working-class person on median income or less that because he’s 30 and has a family to feed, he doesn’t get a tax break, but a 70-year-old who’s doing fairly well gets one?”

Some states may gradually phase out tax breaks for the wealthiest seniors, as competing pressures for tax dollars mount in the decades ahead, Pattison suggested.

“Historically, tax breaks have been hard to get rid of once you start them up unless you do it as part of a major reform in the tax system, and those are few and far between in the last decade,” said Nick Jenny of the Nelson A. Rockefeller Institute of Government.

Virginia is the only state that has rolled back its senior tax preference — passing a major tax-reform package in 2004 that phased out income-tax exemptions for seniors making more than $50,000. “It shows it can be done,” said McNichol.

Meanwhile, Georgia, which exempts Social Security benefits, recently passed a law exempting the first $35,000 in other retirement income. And Wisconsin passed a law last year, expanding its Social Security exemption. Both laws are slated to take effect in 2008, when the first baby boomers become eligible for Social Security benefits.

At least three states — Maine, Maryland and Idaho — are considering laws this session that would eliminate taxes on some retirement income.

The Center acknowledged that adjusting senior tax breaks could be politically difficult, particularly because older Americans vote in disproportionately large numbers and are often vocal about their needs. The group recommends that states reform senior tax preferences by either raising the eligibility age to 75 — a demographic with a higher poverty rate than 65 and older — or excluding income over a certain level.

The report also suggests that property-tax relief limit the percentage of a household’s income that people can be expected to pay in property tax, rather than exempt a specified percentage of a house’s value from the tax.