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Seniors: How Taxed Are They?

The editor of Public Policy & Aging Report asks if tax regimes set up when the words 'elderly' and 'poor' were nearly synonymous may have outlived their good intentions.

The growing presence of older people in American political and economic life has been one of the major developments of the past half-century. With the leading edge of the baby boomers about to enter old age, seniors' significance can only become yet more pronounced.

While no one doubts that the "graying of America" is a big story, very different versions of that story are in wide circulation.

One group of commentators sees storm clouds on the horizon, with Social Security and Medicare entitlements leading to trillion-dollar federal deficits, younger workers being squeezed out of the job market, and long-term care costs bankrupting state Medicaid budgets. A very different reading finds success rather than excess, with Social Security being seen as largely responsible for a fourfold decrease in poverty among the old, Medicare having doubled the proportion of seniors with health insurance coverage and a rising generation of seniors doing so well that they can be contributors to economic growth rather than drains on the public fisc.

Most of this debate has centered on the spending side of the public policy equation, that is, are we allocating an appropriate amount for older people? Are the right older people receiving the benefits? Are old-age benefits crowding out benefits to younger populations? And, perhaps most importantly, does old age remain a good proxy for need in light of how relatively well many among the current generation of older people are faring?

Less attention has been paid to the revenue-generating side of this policy equation, i.e., taxation. While we know that seniors have been notable beneficiaries of public expenditures, we know less about whether they have also been favored as taxpayers. Moreover, have the same arguments about seniors' particular needs and status in life that have justified spending programs also informed decisions about whether the tax code should treat seniors differently than it treats everyone else?

The current issue of Public Policy & Aging Report — the quarterly publication of the National Academy on an Aging Society — addresses these taxing questions. Karen Conway and Jonathan Rork provide a history of age-based tax provisions in federal and state tax codes; Rudolph Penner reviews age-relevant aspects of federal tax law; John Gist presents a profile of the diversity of older taxpayers; Elizabeth McNichol questions current justification for many state-level elder tax breaks, and David Baer assesses the relative and absolute burden of local property taxes on older residents.

These articles address several important issues and present an array of interesting and, occasionally, surprising findings.

The first federal "tax break" for elders came with the Social Security Act in 1935, when the decision was made not to tax Social Security benefits because, as recounted by Penner (a fellow with the Urban Institute), benefits were initially so low it wasn't worth the administrative cost to tax them. A special exemption for people over 65 was enacted as part of a Republican tax cut bill in 1948, passed over President Truman's veto.

Virtually all of the states enacted tax breaks for elders in the post-World War II years. Of these, most interesting has been the expansion of EIG tax breaks (estate, inheritance and gift taxes), which were enacted in the name of what economists Conway and Rork call "interstate tax competition for the elderly" — seniors being a population seen as combining relatively high incomes and low state-level costs (the federal Social Security and Medicare programs bearing the lion's share of public support for older people).

The most pressing issue pertaining to seniors and taxes centers on the size and continuing appropriateness of special provisions. Several authors here address this question. Both Conway and Rork and Penner note that federal tax breaks for seniors began fading in the late 1970s. The 1983 Social Security reforms (Greenspan Commission) led to the first taxation of Social Security benefits; the Tax Reform Act of 1986 switched an elderly exemption to an additional standard deduction for non-itemizers, and the threshold for Social Security taxation was increased in 1993.

However, tax provisions benefiting seniors remain widely in place at the state level.

McNichol's review finds that of the states with income taxes, all but five offer extra exemptions or credits to persons age 65 and older, and these are generally not limited to low-income elders. Four states exclude all pension income, both public and private, from taxation, with 26 of the 42 states that have income taxes excluding Social Security income from taxation. Only limited data on the costs of these benefits to the states is available, but among the 22 states where tax expenditure data is available, McNichol — an analyst for the Center on Budget and Policy Priorities — reports that elder-oriented tax expenditures equal 9.3 percent of general fund revenues in Mississippi, 7.8 percent in Pennsylvania, 7.5 percent in Kentucky and 7.1 percent in North Carolina.

There are, of course instances where older people may be considered to be unfairly burdened by tax obligations. Thus, in Baer's analysis of property tax burdens using the Census Bureau's American Community Survey, he finds that the older households experienced higher burdens than younger ones in almost all of the states, due largely to the older owners tending to have lower incomes. The scholar with the AARP's Policy Institute finds that older homeowners also face higher tax burdens than younger ones with identical incomes, although this is partially explained by the older owners often residing in higher value homes.

In all of these discussions, it is important not to lose sight of the variability in both income and tax consequences among older citizens. Thus, Gist, also a scholar with the AARP Policy Institute, reports that only roughly half of older persons actually file federal income tax returns, and only half of those individuals have taxable income. Between exemptions and personal deductions, the tax threshold for older people is $10,500 for an individual and $19,600 for a couple. And, while 40 percent of seniors report income from capital gains, compared to only 16 percent for those under age 65, it is also the case that Social Security constitutes the only source of income for 20 percent of seniors and 60 percent of income for one-half of all seniors.

The most salient policy question emerging from these disparate patterns is the extent to which age-based tax benefits remain consistent with their original intent. Clearly, seniors have been historically favored because of the long-standing reality — now in question due to improvements in their aggregate well-being — that they were singularly poor, vulnerable and deserving. McNichol, among others, suggests that low income should be increasingly used to assess economic vulnerability, arguing that advanced age is an increasingly misleading proxy for need. Yet, the relatively fixed incomes of many older people and their frequent inability to return to the labor force in time of economic need may make them vulnerable in ways younger people are not.

And then, as noted by Penner, many age-oriented tax provisions are about generating or protecting retirement income, provisions which can be understood in life-cycle as well as old-age terms.

People who study social policy and aging often invoke the concept of "structural lag" to characterize how public programs have not kept up with the changing status of seniors over the past four or five decades. While such analyses often point to problems such lags have created for certain seniors, e.g., elderly widows, a review of tax policy can lead to a different conclusion, namely, that at least some of the provisions may have outlived their appropriateness. Again, the picture is mixed, but in these times it is difficult to wholeheartedly endorse Hawaii, Illinois and Mississippi's excluding from taxation all public pension, private pension, Social Security income, as well as providing an additional personal exemption or higher standard deduction.

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