Academic journal article Economic Review - Federal Reserve Bank of Kansas City

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

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

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

Article excerpt

The U.S. population is getting older. In 2011, the first mem- bers 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 gov- ernment 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 de- gree 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 pro- jected migration rates.

This article examines the effects of aging populations on tax rev- enue 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 pro- portion 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 co- horts 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 re- ductions 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, consum- er 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 pay- ments, 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. …

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