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 Illinois exempts all retirement income from state taxes - Social
Security, private and public pensions, and annuities. We’re leaving
$2 billion on the table annually, according to the state’s
estimates. And we’re hardly alone: 36 states that have an income tax
allow some exemption for private or public pension benefits, and 32
exempt all Social Security benefits from tax, according to the
Institute on Taxation and Economic Policy (ITEP). States currently
considering wider income tax exemptions for seniors include Rhode
Island and Maryland.
With the April 15 tax day just around the corner, it’s a timely
moment to ask: What are these politicians thinking?
Income tax exemptions date back to a time when elderly poverty rates
were much higher than they are today (federal taxation of Social
Security began in the 1980s). As recently as 1970, almost 25 percent
of Americans older than 65 lived in poverty, according to the Census
Bureau; now it’s around 9 percent. Today, it still makes sense to
tread lightly on vulnerable lower-income seniors, many of whom live
hand to mouth trying to meet basic expenses. And the number of
vulnerable seniors is on the rise (http://reut.rs/1olYGn7).
MORE SENIORS
But much of the benefit of state retirement income exemptions goes
to affluent elderly households. The cost of these exemptions is
high, and it’s going to get higher as our population ages. In
Illinois, the number of senior citizens is projected to grow from
1.7 million in 2010 to 2.7 million by 2030. That points to a
demographic shift that will mean a shrinking pool of workers will be
funding tax breaks for a growing group of retirees.
So there’s a real need for states to target these tax breaks to
seniors who really need them. Yet one of the plans floated in Rhode
Island would exempt all state, local and federal retirement income,
including Social Security benefits - from the state’s personal
income tax. The Social Security proposal is an especially good
example of a poorly targeted break.
Currently, Rhode Island uses the federal formula for taxing Social
Security, which already protects low-income seniors from taxes.
Under the federal formula, beneficiaries with income lower than
$25,000 ($32,000 for couples) are exempt from any tax (income here
is defined as adjusted gross plus half of your Social Security
benefit). Up to 50 percent of benefits are taxed for beneficiaries
with income from $25,000 to $34,000 ($32,000 to $44,000 for married
couples). For seniors with incomes above those levels, up to 85
percent of benefits are taxed.
If Rhode Island decides to exempt all Social Security income from
taxation, more than half of the benefit will flow to the wealthiest
20 percent of taxpayers, according to an ITEP analysis.
“The poorest seniors in Rhode Island wouldn’t get a dime from this
change, because they already don’t pay state taxes on Social
Security,” says Meg Wiehe, ITEP’s state tax policy director.
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WORKING LONGER
Another tax fairness issue is inequitable treatment of older workers
and retirees. The percentage of older workers staying in the labor
force beyond traditional retirement age is rising - and many of them
are sticking around just to make ends meet. Those workers are
bearing the full state income tax burden, effectively subsidizing
more affluent retired counterparts.
Some tax-cut advocates might argue that breaks for seniors will help
retain or attract residents to their states. But numerous studies
show that few seniors move around the country for any reason at all.
Just 50 percent of Americans age 50 to 64 say they hope to retire in
a different location, according to a recent survey by Bankrate.com,
and the rate drops to 20 percent for people over 65.
For those who do move, taxes are a consideration - but not the only
one.
“A lot of factors go into the decision,” says Rocky Mengle, senior
state analyst at Wolters Kluwer, Tax & Accounting US. “Climate,
proximity to family and friends are all very important, along with
the overall cost of living. But I’d certainly throw taxes into the
mix as a consideration.”
Smart tax policy makers and politicians should take all these
factors into consideration - especially in states that are facing
crushing deficits and debt burdens. Targeted exemptions for
vulnerable seniors make sense, but the breaks should be
affluence-tested.
“The scales would vary state to state,” says Wiehe. “But a test that
makes sure taxation isn’t a blanket giveaway with most of it going
to the most affluent households.”
Indeed. In the golden years, not all the gold needs to go to the
rich.
(Editing by Ted Botha)
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