A Senior Moment

Is a tax break specifically for seniors good policy?  A look at the issues and evidence.

Their numbers are growing rapidly.  They like to vote.  They are by and large more mobile than any other age demographic and are generally the wealthiest.  With respect to their net fiscal impact, some are (in the words of one researcher) “pure gold” to have around while others are disproportionately large users of state government services.  And over a longer period of time some may fall under both these categorizations.

As this year’s House and Senate omnibus tax bills demonstrate, as far as priority audiences for tax relief go, seniors are near the top.  As highlighted above, senior tax relief does give lawmakers some interesting political and policy implications to think about.  But its inclusion also fundamentally changes the calculus of tax relief available to other taxpayers which were prime tax relief targets in the “almost” tax bill of 2016 and remain so today – like farmers, households with kids, college graduates with student loans, and rural businesses.

Republican legislators have been the most vocal proponents, introducing several bills putting state taxation of Social Security benefits directly in the crosshairs.  Four bills were introduced calling for 100% exemption of Social Security benefits – the only difference being the timelines involved.  Unsurprisingly, these are not cheap proposals.  Even the most gradual phase in – exempting an additional 10% of currently-taxable benefits each year for the next decade – has a $135 million price tag for the coming FY 18-19 biennium, which ramps up to $365 million for FY 20-21.  DFL interest centered around a less expensive and not surprisingly more progressive approach which reduces the tax relief for higher earners.

Ultimately, both the House and Senate omnibus bills embraced this more targeted approach allowing a subtraction of Social Security benefits from taxable income, subject to limitations.  The maximum value of the subtraction differs between the bodies – the House bill provides for a complete subtraction of benefits up to a phase-out threshold, while the Senate bill allows a maximum of $2,500 in benefits (for married-joint filers; scaled for other filing types) to be subtracted.  In both bills the subtraction is phased out for filers with “provisional income” (i.e. the income used to calculate the federally taxable portion of Social Security benefits) greater than certain threshold amounts.  However, these threshold amounts and the associated phase-out rates differ between the bills.  Notably, the “thresholds” above which Social Security benefits are taxed have never been adjusted for inflation since they were first put in place in the mid 1980’s.  Going forward, the Senate version corrects for this de facto “bracket creep” by adjusting all thresholds for inflation.  Projected budget impacts for the House and Senate versions for FY 18-19 are $269.1 million and $74.9 million respectively.

Meanwhile, Governor Dayton has been circumspect on senior tax relief, occasionally expressing caution about the long-term revenue implications of such proposals.  The only senior-targeted tax initiative in his budget is enhancements to the senior citizen property tax deferral program to make it more accessible and easier to use.

No Country for Old Men

Unlike nearly all other states Minnesota offers little in the way of preferential income tax treatment for seniors.  Minnesota offers no special deduction, exemption or tax credit based solely on age, no general exemptions for pension income, and no favorable treatment of Social Security benefits above and beyond that offered under federal law.  The results of these policy choices can be seen in the results of our own Multistate Individual Income Tax Comparison Study.  As the accompanying table shows, Minnesota consistently ranks as the highest senior income tax state in the nation at middle and upper income levels.  The ”burden above U.S. average” column only includes states with personal income taxes; the differential for the nine states without a personal income tax is, of course, the Minnesota income tax burden itself.

Table 1

Minnesota Results from Tax Year 2013 Multistate Individual Income Tax Comparison Study

For higher income seniors, might favorable treatment in other Minnesota tax areas offset whatever comparative disadvantages exist in state income taxation?  Perhaps, but not likely to any significant degree.  Our 50 State Property Tax Comparison Study finds urban and rural homestead taxes are near national averages.1 Minnesota does have a far more generous and accessible general property tax refund program than other states, but most other states do offer some type of exemption or refund program specifically for senior households.  Moreover, the Minnesota property tax refund program is income-tested so fewer refund benefits accrue to those households paying comparatively more in senior income taxes than they would in other states.  For example, according to the 2015 Tax Incidence Study, the average property tax refund of the top 30% of Minnesota senior income households is only $66 – which represents a small savings relative to the higher income tax burden they pay.

Similarly, sales tax treatment of seniors is unlikely to materially offset disadvantages in income taxation. Generally speaking, the portfolio of goods and services comprising Minnesota’s sales tax base is not significantly different from most other states – including the non-taxation of senior consumables like prescription and over the counter drugs.  The high profile exception – clothing – may be an iconic and popular feature of Minnesota taxation but clothing only constitutes 3-5% of total senior expenditures.2  Our more limited use of local sales taxes could be considered an advantage, but that is offset by our comparatively higher general sales tax rate.

In short, Minnesota’s ranking as the third least friendly tax state for retirement by Kiplinger’s personal finance magazine appears justified.  The primary policy questions for legislators are 1) does that even matter, and 2) if so, what are the potential fiscal impacts on the state in addressing it?

Fall Migration Patterns

From the purest tax policy perspective, there is no theory of taxation justifying favorable income tax treatment simply on the basis of age.  Evaluated on principle, such efforts would routinely violate tax fairness – albeit the less appreciated and recognized “horizontal equity” version.  But the elderly do face greater limitations on obtaining more income, unlike younger but income-equivalent counterparts.  Ensuring senior health and enhancing protections against senior poverty is why one reason why legislators have expressed interest in senior income tax preferences.

Evidence suggests, however, that state senior income taxation does not appear to have a major influence on senior income security.  According to the 2015 Tax Incidence Study, the bottom half of all Minnesota senior households (which reflects incomes below $46,408) have an average state income tax burden of only $126. Since most of the tax-related benefits of exempting larger amounts of Social Security income would accrue to higher income senior households, the primary policy outcome is likely to be the enhanced protection of retirement lifestyles rather than enhanced income security.

Another more frequently heard argument concerns taxpayer mobility:  the need to attract –or perhaps in Minnesota’s case simply retain –an economically important demographic:  the higher income retiree.  Several studies have documented the importance of seniors to an economy – especially the prime “young –old,” amenity-seeking retirees possessing above average incomes, wealth, and work experience.  They spend money that generates jobs within their local economies; they place fewer demands on community services like schools; they frequently continue to work in some capacity, which adds to state revenues; and they meet important volunteer needs in the non-profit sector.  One economist has concluded that a senior citizen with retirement income has an economic multiplier of 3.1 compared to 1.7 to 1.8 for the average consumer.3  Another study estimated it takes 3.7 manufacturing jobs to equal the economic impact of one new retiree household.4  The proliferation of special tax breaks for seniors across the country over the past couple of decades suggest this has not gone unnoticed by legislators.

One important question is whether higher income seniors respond to these incentives.  Unsurprisingly, academic research findings are mixed with “do they or don’t they” conclusions dependent on the methodological approaches employed and their incomprehensible econometric details.  One noteworthy study that examined changes in state tax breaks over time and migration trends covering four U.S. census periods adamantly concluded, “our results are overwhelming in their failure to reveal any consistent effect of state income tax breaks on elderly interstate migration.5  However, the authors also note that their analysis ends with migration that took place before 2000 – long before the large, wealthier, more active cohort of baby boomer retirements commenced – and acknowledge, “current elderly could be behaviorally different from their predecessors.”

To gain some additional perspective on the migration patterns of higher income seniors we examined the Public Use Microdata Sample from the Census Bureau’s American Community Survey for each year between 2011 and 2015.  We focused specifically on wealthier senior households (age 65 and with at least $75,000 of income6) who reported living in a different state in the previous year, and their in-migration to Minnesota or out-migration from Minnesota with respect to neighboring states (the Dakotas, Iowa, Wisconsin, and Illinois) and classic sunbelt retirement states (Arizona, California, Florida, and Texas).  Based on the data, we estimate about 6,000 of these individuals left Minnesota for these states while about 3,000 migrated into Minnesota from these places, for a net loss of about 3,000 of these individuals over the 5-year period, or about 600 per year.

Using the revenue estimates associated with the Social Security exclusion bills offers some insight into the cost effectiveness of using Social Security tax policy to retain retirees.  Even just exempting 10% of the current Social Security income base would cost $42.4 million in the first year – or $71,000 for each of the 600 net seniors with higher incomes who leave each year.  Clearly, those amounts go up if more Social Security income is exempt.  A full national analysis of this cohort’s migration in and out of Minnesota might show a larger net migration and thus lower “cost per senior to retain.”  Still, it seems reasonable to conclude that an across-the-board Social Security tax break is a rather expensive way to try to stem the net loss of higher income seniors for the simple reason that so much of the benefit would be directed to individuals who would stay in Minnesota anyway.

Putting State Budgets at Risk?

At the same time Minnesota is exploring new tax relief to seniors, other states are investigating ways to roll back the favorable treatment they currently provide.  Both Georgia and Michigan have frozen or rolled back income tax exemptions on seniors’ income while a 2013 blue ribbon commission on tax reform in Kentucky concluded the state could bring in nearly a half a billion dollars annually in needed revenue by reducing income tax exemptions on pension benefits.  The fact that policymakers have pursued these rollback efforts in spite of their unpopularity and political risk suggests a growing recognition that these tax system features are setting states up for potentially big budget problems in the future – budget problems influenced by the same demographic group Minnesota is targeting for relief.

An investigation several years ago offers some interesting insight on the revenue related implications of an aging population and on providing more favorable tax treatment to this demographic.  The study explored the revenue impact of an aging Minnesota population by simulating what Minnesota tax revenues in 2007 would have looked like by superimposing projected 2035 demographics, income sources and labor force participation onto the then-current (2007) tax law.  Importantly, the investigation examined only the direct impact on income taxation – it ignored indirect impacts like age induced lower rates of economic growth and increased pressures on government spending.  Researchers found retirement income receipts (pension and Social Security) would be 34.4% higher but would be more than offset by declines in both earned and capital income.  The result was a hypothetical 7.5% decline ($535 million) in 2007 individual income tax receipts relative to what was actually collected.

Of course, Minnesota offers nothing in the way of senior preferences, so any effort to start doing so would result in projected greater losses going forward.  The accompanying table highlights how enacting several types and combinations of senior preferential tax treatments would affect the scenario the researchers modeled (i.e., 2007 revenues under 2035 characteristics).  As the table notes, for Minnesota to match the senior tax treatment offered by a typical state (Option E), the estimated decline in income tax revenues would more than double.

Table 2

Estimated Changes from Enacting Selected Senior Tax Preferences to 2007 Minnesota Income Tax
Revenues (Adjusted for 2035 Characteristics)

Researchers concluded that even without new senior preferences, states face declines in income tax revenue due to an aging population, and states like Minnesota with limited senior preferences face an even greater potential loss should they choose to mimic the preferences other states provide.

Meanwhile, spending pressures on government programs serving this demographic are growing.  Many younger retirees will become over time part of a senior population requiring some form of long-term services and supports (LTSS).  A 2013 Congressional Budget Office study on growing demand and rising costs of LTSS offers some perspective on the looming challenge:

Anticipated federal health care reforms only further complicate the calculus of senior tax relief.  As we noted in our last issue of Fiscal Focus, personal income-adjusted Medicaid block grants alone could cost the state $1 billion or more in annual federal revenue.  The Congressional Budget Office estimated enactment of the American Health Care Act would increase the number of uninsured individuals by 24 million and raise the out-of-pocket health care premiums for a typical low-income 64-year-old senior from $1,700 to $14,600 a year.  Although the AHCA ultimately failed to pass the U.S. House, any health care reform seems likely to create some level of financial challenge for seniors.  This creates a dilemma.  Facing these types of outcomes and financing responsibilities, states will be compelled to hang on to every tax dollar they can get.  At the same time, such reforms will put even more pressure on seniors and their legislators to help them retain every dollar of income they can.

Health care is just the most visible example of policy proposals that are primed to delegate far more responsibilities to states for the financing and delivery of essential public goods and services.  A recent report described how Minnesota could lose $80 million in federal support for childhood immunization programs and infectious disease monitoring requiring more state backfilling.  From public health to infrastructure to tax administration to environmental protection, nearly every area of government is directly or indirectly exposed to budget uncertainty.

It’s in this context that senior tax relief – and for that matter any tax relief or new program spending being considered in 2017 – also needs to be evaluated.  That is especially true for a high tax, high service state like Minnesota which has historically struggled with embracing government redesign ideas and thinking about government spending in terms of priorities as a way to address uncertainty, risk, and exposure.  As a result, building a state budget in this environment is akin to playing Texas hold ‘em with the federal government.  The state might be prudent to check and see the flop before going all in with very large and ambitious new tax or spending policies.

  • 1 Of course money has to come from somewhere and states with no individual income tax often will feature higher property taxes.  For example, a $150,000 home in Houston pays $682 more in property taxes than an equivalently valued home in Minneapolis and a $300,000 home pays $1,068 more.
  • 2 “Expenditure Patterns of Older Americans” Employment Benefit Research Institute, 2012
  • 3 “Do Senior Citizen Tax Breaks Pay For Themselves?”  Governing, April 25, 2013
  • 4 “Manufacturing or Retirement: A Comparison of the Direct Economic Effects of Two Growth Options” Green and Schneider, Arkansas Business and Economic Review, 1989
  • 5 “No Country for Old Men (Or Women):  Do State Tax Policies Drive Away the Elderly?”  Conway and Reed, National Tax Journal; June 2012
  • 6 In constant 2015 dollars.