Here’s a state-level idea that represents sound public policy and, fortunately, is attracting important bipartisan support: trimming tax breaks for pension income. Among the state leaders who have proposed it are Michigan’s Republican governor, Rick Snyder, Hawaii’s Democratic governor, Neil Abercrombie, and the Democratic president of the Illinois Senate, John Cullerton.
As I explained in a 2006 report, most states fully or partially exempt pension income from income taxes and more than half fully exempt Social Security income. Often, the pension income breaks are not targeted by age or by income.
Decades ago, when states created many of these tax breaks, elder poverty was much more widespread than it is now, and it seemed reasonable to relieve the tax burden on the elderly. But the decline in elder poverty since then means that many of those tax breaks now benefit taxpayers who are at least as able to pay taxes as non-elderly residents are. Moreover, in many cases, the seniors who benefit most from a given tax break are those with the highest incomes.
Most important, those tax breaks will become significantly more costly over the next few decades as the elderly’s share of the population grows. Those growing costs will make it harder and harder for these states to maintain high-quality public services, which can have a big impact on the quality of life in a state.
By better targeting their income tax breaks on low-income seniors, states can free up scarce funds for other purposes. The logical place to start is by recouping some of the revenue lost due to the recession, thereby somewhat averting states’ needs to make deep cuts in public services for seniors and others. Less sensible is to spend that money on other tax breaks — such as cutting business taxes — that most states can’t afford, as Michigan’s governor proposes.
Nonetheless, all three deserve praise for tackling unnecessary tax breaks for senior citizens.