Tax breaks for the elderly.

Brannon, Ike

"Do Tax Breaks for the Elderly Promote Economic Growth?" by Ben Brewer, Karen Smith Conway, and Jonathan Rork. University of New Hampshire working paper, April 2016.

States compete on taxes in myriad ways. Several states do not have an income tax. Others have reduced taxes on businesses large and small. (Kansas has gone so far as to have abolished small businesses taxes two years ago.) And, of course, states offer a wide variety of tax breaks with the intent of luring specific industries or businesses to locate or remain in their realm.

But many states also compete for senior citizens by offering a lower tax rate for pension income. How states do this varies greatly. Some exempt military pension income from the state income tax altogether. Others offer tax breaks for public employee pensions and Social Security benefits as well. Still others give tax breaks for all pension income, whether public or private.

The rationale for this is that senior citizens don't place much of a demand on state services--their children are usually done with public schools, for instance--so having seniors around costs the state relatively little. The authors of this working paper acknowledge that fiscal tradeoff, but they suspect there's little reason to believe that retirees are influenced all that much by the tax breaks. Many retirees are unwilling to trade that home state--where their friends, relatives, and grandkids are abundant--for a neighboring state just to save a few grand a year. And the retirees who do move often "snowbird" in Florida for just six months (and one day, of course, to qualify as residents) and then return to their home states.

Or so the authors thought. The reality, they found, is that lower tax rates on retiree income do boost a state's economic growth. Why this is so remains a mystery to the authors: they do find that taxes on lower-income workers seem to matter the most to seniors, so it's tempting to construct some sort of Keynesian aggregate-demand story to explain the higher economic growth. However, if fiscal stimulus spending can't explain sustained higher growth rates in an economy, then it seems unlikely that lower tax rates on seniors would do so.

I have an alternative hypothesis that's broadly consistent with their data. Hundreds of communities across the country are chasing prospective "angel investors": wealthy folks (but not exorbitantly so; think of a developer in a small city who sold the business for $15 million when he hit 60). These folks are not quite ready to retire, but they've wisely cashed out on their career. Yet they still have a desire to chase one or two more "big ideas." They won't risk their entire nest egg, but if they find something promising, they'll be tempted to throw some savings at it, along with their personal attention and skills. And the place they'd want to do this isn't Florida, but their hometowns, where they've lived for decades.

Suppose these potential angels already snowbird, returning home in the summer to see the grandkids. They're less inclined to try a business idea if they're only going to be in-state for less than half of the year. But if their home states adopt senior-friendly tax cuts, the Florida retirement village may no longer seem so inviting. Sure, they'll still go south to skip the worst of the winter, but they'll spend more time back home, where they'll be more inclined to try that startup and give it a decade to see if it flies. And if it does (or even if it doesn't), they might then be inclined to try another idea.

Ohio Gov. John Kasich (R) offered this idea to support tax breaks implemented in Ohio in 2011, and there's some evidence that it's working. It is, of course, a controversial idea that, for what it's worth, the AARP rejected vehemently when the breaks were first proposed, precisely because they mainly benefited upper-income seniors. (Perhaps those folks are less likely to join the organization?)

It is worth noting that the working paper authors didn't expect to find that retiree tax rates significantly affected economic growth. But to their credit they behaved like real scientists, did yeoman's work in discerning the robustness of their result (very), and then set forth trying to explain it--and not explain it away.

This is fertile ground for much more research.

--Ike Brannon, Cato Institute