Time to talk about senior tax breaks?

AS THE POPULATION AGES, STATES MAY NEED TO RECONSIDER TAX PREFERENCES FOR OLDER AMERICANS.

The United States is aging. In 1900, only 4 percent of Americans were 65 or older. By 1950, that percentage had doubled. In the year 2000, according to Census Bureau projections, almost 13 percent of all Americans will be 65 or older, and by the year 2030 one in five Americans will be 65.

In the next 25 years, the older population in eight states - Nevada, Arizona, Colorado, Washington, Georgia, Utah, Alaska and California - will more than double. Another nine states will experience at least 80 percent growth in the 65-plus population. Growth will be most pronounced in the West and Southeast.

Even as the older population has expanded, poverty rates among older Americans have been falling. Social Security, Medicare, and other federal and state programs have been very successful in keeping most older Americans out of poverty. And because poverty figures do not include noncash benefits like Medicare and subsidized housing, they may overstate poverty among older Americans as compared to poor children.

Aging Americans will have profound effects upon the way federal, state and local governments fund and deliver services in the 21st century. A shrinking number of working Americans will pay for the benefits of a growing number of retirees. At the federal level, the Old Age Survivors and Disability Insurance funds (OAS/DI) may be depleted by the year 2036 based upon current tax rates and benefit levels.

States will have to change their tax systems to consider an aging population with fewer working age taxpayers and more elderly citizens using state and local services. For example, through the Medicaid program, states currently fund between 20 percent and 50 percent of nursing home costs for the indigent elderly with federal matching funds paying the rest. Medicaid has been one of the fastest growing components of state expenditures between 1988 and 1994, and long-term care has been one of the largest growth components within state Medicaid programs.

As the population ages, more and more elderly taxpayers will benefit from the tax preferences now available in most states. Yet most legislatures have not yet taken a critical look at how tax benefits for the growing elderly population will affect their revenue systems. In fact, lawmakers in recent years have been expanding, not curtailing, tax preferences for older Americans. Why?

There is no one reason to explain the proliferation of tax breaks for the elderly. However, some key issues are common to most states:

* Interstate Competition. Some states use their tax systems in an attempt to become retirement havens. Senior citizens who have the resources to be mobile are likely to place fewer demands on state and local services and may bring significant personal wealth to a region. In 1993, Mississippi repealed all income taxes on pension income in an effort to lure wealthy retirees to the state. Florida has no income tax in part to make it attractive to retirees. Northeastern and Midwestern states have cut estate and inheritance taxes in order to dissuade wealthy retirees from moving to Florida and other Southeastern states with lower death tax burdens.

* School Taxes. Some states may be responding to seniors' concerns about paying property taxes for schools. School taxes represent most of the total property tax bill, and lawmakers are sensitive to the perception that seniors receive few direct benefits from them. In most of the New England states, for example, school budgets must be approved by the voters. Since older Americans tend to vote at higher rates than other age groups, tax relief measures may be instrumental in gaining passage of school budgets.

* Tax Revolts. Some of the 24 states with the voter initiative may provide tax relief to seniors in an effort to prevent passage of even more stringent anti-tax measures through citizen initiatives. The property tax is seen as particularly onerous for seniors; they may fear losing their homes because of high property taxes. Older Americans are likely to support property tax limitations that severely restrict local revenue from all sources, not just from older homeowners. Older Americans were a key voting bloc that helped pass California's Proposition 13, for example.

These pressures have pushed states into adopting several kinds of tax preferences for the elderly. To alleviate the burden of school property taxes and property tax burdens generally, states have expanded the use of circuit breaker and homestead exemption programs for older homeowners and renters. Circuit breaker programs, which provide a state funded rebate for excessive property taxes, are offered in 32 states - 22 of these states offer programs only for older taxpayers. Homestead exemption programs, which exempt part or all of a home's value from taxation, are available in 36 states. Every state except Wyoming has either a homestead exemption or circuit breaker program.

States have also moved to eliminate parts of their tax code that give wealthy retirees an incentive to relocate to retirement havens like Florida and Nevada. In 1994, Ohio eliminated the inheritance tax on property transferred to a surviving spouse, and Pennsylvania began a phase-out of the same tax. Kentucky, Michigan and Massachusetts also acted in the last few years to reduce or eliminate inheritance taxes.

Four other states cut income taxes on older taxpayers in 1994 sessions by increasing standard deductions and personal exemptions. Michigan was the most generous - the Legislature increased the exclusion for pension income from $7,500 to $30,000 for single fliers ($60,000 for joint fliers) and created a new $1,000 exclusion ($2,000 joint) for interest and dividends. Georgia, Minnesota and Virginia also increased the amount of income that older taxpayers can earn tax-free. In a 1995 special session, Kentucky repealed the property tax on intangibles like stocks and bonds and excluded more pension income from taxation.

Will demographic pressures force states to curtail tax preferences for the elderly, or will interstate competition and political pressures continue to make tax breaks for older Americans an attractive item on legislative agendas? No one knows. However, as lawmakers consider expanding tax breaks for retirees, they may want to ask some tough questions:

* Should relief be provided across the board or only for taxes that are particularly onerous to older Americans? In most states, the property tax is most burdensome to older taxpayers.

* Should relief be provided to older Americans as a class or should it be targeted to low-income seniors? Interstate competition for wealthy retirees pushes states to adopt tax relief for all seniors while fairness dictates that breaks be aimed at those in need.

* What do tax preferences cost the working population? Today's workers face a much larger federal payroll tax to support Social Security and Medicare than did previous generations. Targeting tax breaks to senior citizens can exacerbate the intergenerational transfer of wealth from workers to retirees, which will become more pronounced as the proportion of elderly Americans increases during the next three decades.

How legislatures answer these questions will determine what state revenue systems look like in the 21st century. Lawmakers need to balance the pressure for tax relief from a vocal and growing elderly population with demographic realities. State revenue systems that rely on a shrinking proportion of workers will not be able to sustain even current levels of government services, not to mention the growing demands of an aging population.

STATES RANKED BY GROWTH IN OLDER POPULATION

Nevada                     122.7%
Arizona                      11.3
Colorado                    108.7
Washington                  104.9
Georgia                     104.6
Utah                        104.3
Alaska                      103.8
California                  101.6
Texas                        99.5
New Mexico                   99.4
Florida                      95.5
Hawaii                       92.6
Idaho                        90.7
North Carolina               89.0
Virginia                     85.9
South Carolina               85.4
New Hampshire                80.9
Oregon                       75.7
Tennessee                    74.1
Maryland                     70.1
Delaware                     67.8
Minnesota                    62.6
Vermont                      61.8
Arkansas                     61.1
Alabama                      61.0
Montana                      56.8
Mississippi                  56.2
Louisiana                    52.8
Kentucky                     52.1
Oklahoma                     52.0
Maine                        51.5
Wisconsin                    51.0
Kansas                       57.3
Wyoming                      46.0
Missouri                     45.7
Indiana                      44.8
Nebraska                     40.3
New Jersey                   39.1
Connecticut                  37.6
Michigan                     36.1
South Dakota                 35.2
Ohio                         35.0
Massachusetts                33.0
Illinois                     33.0
Rhode Island                 27.5
New York                     27.4
North Dakota                 27.2
Iowa                         26.2
West Virginia                24.4
Pennsylvania                 21.8
District of Columbia         14.5

Source: National Conference of State Legislatures

Scott Mackey specializes in tax policies for NCSL. His book, State Tax Policy & Senior Citizens (co-authored with Karen Carter), is available free to legislators and staff and for $25 plus postage to others. Call NCSL's marketing department [phone].