There is a significant demographic change occurring in North Carolina that virtually no one is talking about. A change that will have major implications for the state’s fiscal health for decades to come.
With the ageing of the baby boom generation (born 1946-1964), North Carolina is witnessing a meaningful shift in the income source of its residents, as retirement income replaces wage income for more and more seniors in the Tar Heel State.
State budget writers need to pay attention to this shift, as it has serious implications for budget and tax policy in the coming years.
Research provided in a legislative memo from the Fiscal Research Division’s chief economist finds that in North Carolina “retirement income has nearly doubled as a share of total Federal Adjusted Gross Income from 5.7% in 1991 to 10.3% in 2013.”
Moreover, the research showed that our state’s population of residents over 65 as a share of total population grew from 12.2 percent in 2006 to 15 percent in 2015. The memo added “The State Data Center projects that by 2030 over 20% of North Carolina’s population will be 65 or older.”
In short, in just a dozen years, one in five North Carolinians will be age 65 or over. A significant share of which will be fully or partially retired.
What impact will this have on North Carolina’s economy?
According to the memo, “The aging of the population will be a drag on the economy. Simply, an aging population is expected to generate less economic output per capita, all else equal. This will directly impact State revenues because retirees earn and spend less.”
Fewer people in the labor force means lower income, as retirement income typically does not fully replace prior wages. Making matters worse, the memo goes on to say, is “(w)eak savings and insufficient asset portfolios such as 401(k)s coupled with high debt obligations” that will “significantly constrain this aging population in retirement.”
The result is a smaller tax base for the state’s largest revenue source: the personal income tax.
The memo suggests that other factors such as population growth and overall economic conditions can offset the declining tax base, but concludes the likeliest scenario will be tax revenue growing at a “slower pace.”
For state budget writers, this is especially troubling news in light of the rapid growth of unfunded state pension and retiree health care benefits.
For instance, annual minimum required payments for state pension and retiree health benefits total nearly $2.5 billion. That figure is up roughly 87 percent from just five years ago.
The pension fund’s total unfunded liability of $7.9 billion is up a whopping $11 billion over 13 years ago (there used to be a surplus), while the retiree health benefit liability totals nearly $33 billion – up $9 billion over its 2005 amount.
These trends indicate severe upward pressure on budgetary obligations for years to come, at a time when our changing demographics tell us there will be a smaller tax base from which to finance these obligations.
How will legislators continue to balance a state budget with growing spending obligations funded from a shrinking tax base?
Some will no doubt resort to their solution to every fiscal problem: tax the rich. But this is problematic for several reasons, including 1) the “rich” are not significant enough in numbers, especially retirees, to generate adequate revenue, and 2) wealthy people, especially retirees, are not stationary targets. Wealthy individuals are highly mobile and will move to more financially hospitable states, shrinking our tax base even further as they take their income and consumption spending elsewhere.
This leaves legislators with the choice of pension and retiree health benefit reform. On the pension side, transitioning current and new employees from the current defined benefit program to a 401(k)-style defined contribution plan makes the most sense. Employees will have ownership of their retirement funds and taxpayers will be off the hook for any liabilities.
Regarding retiree health benefits, reforms could include asking retirees to pay a small percentage of the premiums, amounting to perhaps $65 to $130 per month depending on the plan in which they are enrolled. More than thirty states require retirees to contribute a significant share towards their health insurance premiums, while fourteen states require retirees to fully fund enrollment in their state health plan.
Offering high-deductible plans coupled with a Health Savings Account (HSA) to retirees can also yield noticeable savings.
North Carolina’s aging population, combined with dramatically rising state retiree liabilities, presents state budget writers with a significant challenge. There is no more time to kick the can down the road. The longer we wait to address these concerns, the more painful the solutions will be.
This article originally appeared in The Fayetteville Observer