The Impact of an Aging U.S. Population on State Tax Revenues

The U.S. population is getting older. In 2011, the first members of the baby boom generation turned 65, an age typically associated with retirement. By 2030, almost 19 percent of the U.S. population will be 65 or older, up from just over 13 percent today. This aging of the population has important implications for state tax revenue because as the baby boom generation retires, the nation's labor force participation rate is expected to decline and, with it, income and spending. Most people earn less and spend less during retirement, suggesting that an aging population could reduce government revenue, particularly from sales taxes and individual income taxes. These sources of revenue make up more than 80 percent of total state tax collections.

While several studies have noted that demographic change will affect tax revenues, few have quantified the projected effects across states. The effect will differ across states because they vary in the degree to which they rely on income taxes and sales taxes. For example, while most states rely heavily on both of these sources, seven states do not impose an individual income tax and five do not assess a general sales tax. Also, some states' tax structures are more progressive than others. And many states differ in the goods and services they tax. Moreover, their populations vary in age composition as well as projected migration rates.

This article examines the effects of aging populations on tax revenue across all 50 states. Isolating the effect of demographic change on tax revenue--by holding constant all other factors (such as likely income growth and other variables)--the results suggest that the aging of the population alone from 2011 to 2030 will reduce both income tax and sales tax revenue per capita in nearly every state. In fact, the analysis shows that if the U.S. population in 2011 had already had the age composition that is projected for 2030--that is, with a greater proportion of retirees--state tax revenue would have been lower by $8.1 billion, or 1.1 percent.

Section I examines income and spending patterns across age cohorts in the United States to explore how the aging of the population can lead to lower revenue from income taxes and sales taxes. Section II projects how much the aging of the population will reduce states' income tax revenue. Section III projects how much it will reduce states' sales tax revenue. Section IV projects the combined effect of these reductions on total state tax revenue.

I. AGING POPULATIONS AND TAX REVENUE

Income and spending patterns change over the lifetimes of workers and consumers, and the impact of these changes on state revenue can be substantial. Most workers' earnings increase during their careers and then fall at older ages, as they reduce hours or retire. Similarly, consumer spending tends to increase as people move from early life to middle age, and then spending declines after retirement. The effects of these changes in income and spending could have significant implications for government budgets because income taxes and sales taxes make up a large share of total government revenue. In recent years, individual state income and sales taxes combined have totaled more than 80 percent of state tax revenue. (1) State governments also rely on federal transfer payments, and thus are exposed to the federal government's dependence on these sources of tax revenue. (2)

Demographic projections

As the baby boom generation retires, the age distribution of the U.S. population will shift. According to the U.S. Census Bureau's latest projections, the population segment of age 65 and older is projected to expand as a share of the total U.S. population from 13.3 percent in 2011 to 18.6 percent in 2030. (3) This trend will be reflected in each state in the nation, though the shift is expected to be more dramatic in some states than in others.

State-level population projections are available from two sources--the Census Bureau and individual state agencies. The Census Bureau last released state-level population projections in 2005. (4) Most individual state agencies have released projections within the past two years and, therefore, incorporate more recent population estimates, including for the years spanning the Great Recession. As such, they are likely more reliable than the Census Bureau projections. However, Census Bureau projections are available for every state while state agency projections are only publicly available for 35 states. (5) For this reason, this article presents both sets of projections, but the analysis will emphasize state agency population projections. State agencies differ in their methodologies for projecting population, but most rely heavily on the most recent estimates of population in addition to assumptions about survival rates, fertility rates, and net migration.

Based on state agency projections for nearly every state, the population segment of people older than 65 is expected to increase as a share of each states total population by more than 5 percent by 2030. (Maine and North Carolina are projected to see their shares increase by more than 10 percent.) The projections suggest that states currently having the largest shares of their populations 65 and older will continue to have the largest shares through 2030. These states include Florida, Maine, West Virginia, Pennsylvania, and North Carolina. By 2030, about one in four residents of these states may be a retiree.

Over the same period, total populations are expected to continue increasing, albeit at a slower pace than in past years. Annual population growth in the United States is expected to slow from about 1 percent in the 1980s and 1990s to a little more than 0.6 percent from 2011 to 2030. This slowdown will stem primarily from the combination of a decreasing birth rate and an increasing death rate, the latter due to the aging of the population.

Growth rates are projected to vary across states. For example, populations in Arizona and Colorado are projected to grow 1.5 percent or more annually from 2011 to 2030, continuing a trend over the last three decades of fast growth due to in-migration. Over the same period, population growth in Maine and Pennsylvania is expected to remain close to zero, continuing the historical trends in these states of growth rates below the national average.

Income tax revenue projections

Average income tax revenue from individuals varies across age cohorts, as taxpayers' incomes and rates of labor force participation change with age. (6) Average wage and salary income tends to rise over a worker's career. Initially, these sources of income may increase as people early in their working lives move from part-time to full-time jobs that make better use of their skills and education. Once workers move into the full-time labor force, many increase their earnings by gaining experience, earning promotions, or switching to higher-paying jobs at other firms or organizations. Average salaries usually continue to increase throughout workers' careers until they retire. Retirement typically takes one of two forms: retiring from full-time to part-time work or completely exiting the labor force. Chart 1 shows the rise and fall of average income across workers' progressive life stages, with average income in 2011 rising from $13,793 (for ages 15 to 24) to $51,169 (for ages 45 to 54), and then declining to $25,417 (for those older than 75).

Labor force participation rates vary dramatically by age as well, as also shown in Chart 1. Only 55 percent of the 16-to-24 population participated in the labor force in 2011, by either being employed or actively looking for a job. Participation rates peaked for those 35 to 44, with almost 83 percent participating. At retirement, participation rates fell sharply, with only 26.4 percent of those 65 to 74 and 7.5 percent of those 75 and older remaining in the labor force. (7)

Labor force participation rates have changed over the years, primarily driven by an increase in participation among women and a decrease among men. (8) However, since the mid-1980s, labor force participation rates have trended upward for people older than 65, who began retiring later or taking part-time jobs as a bridge between full-time employment and full retirement (Sjoquist, Wallace, and Winters).

Income tax collections generally follow the distribution of wage income across age groups. Income tax collections are lowest for young workers aged 15 to 24, many of whom work part time and earn entry-level salaries. Tax collections increase for older workers, peaking among 45- to 55-year-olds then falling as workers begin to retire (Chart 2).

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Most states that assess individual income taxes have collections that follow this pattern of rising and then falling across age cohorts. However, different tax structures and distributions of taxpayer earnings produce variation across states. The degree to which different states' tax structures are more or less progressive causes some variation. Under more progressive tax structures, higher earners--who tend to be concentrated in middle-aged cohorts--pay a higher share of taxes than lower earners in the younger and older age cohorts. For example, in California, where tax rates range from 1.0 percent to 13.3 percent, the highest-earning age cohort--45 to 54--on average pays 2.2 times as much as the 25 to 34 cohort. In contrast, in Colorado, which has a flat tax rate, the 45 to 54 cohort pays 1.8 times more in taxes than the 25 to 34 cohort. (9) In addition, many states have tax policies that lower the effective income tax rate for older individuals. For example, 36 states did not tax Social Security income in 2011, and many states do not tax some pension and retirement income (Olin). …

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