By Holley Ulbrich  |  A proposal has been floated to exempt retired state employees from paying state income taxes.  The basis for this proposal is that the only cost-of-living adjustment retirees get from the state retirement system is an annual 1% of their pension, with a maximum of $500 a year.  

Since inflation has been a good bit higher than 1% in the last couple of years, the complaint is understandable.  It’s just not clear that exempting state retirees from state income taxes is a good solution.

Who would benefit? Because of the way the income tax system is structured, the benefits would go to higher-income retirees, while retirees with less than median income would gain nothing. They are already not paying any state income tax. 

Why?  Let’s look at some approximate numbers.  The average state retiree gets a pension of about $21,000. An average Social Security payment to accompany that pension of about $14,000. Social Security is not taxable in South Carolina. There is a $10,000 pension exclusion and a standard deduction of about $15,000 for those over age 65. So that “average” state retiree (single, 65 or older) who has an income of up to  $40,000 consisting of only social security and a state pension is already not paying any state income tax . All of the benefits of the [proposed] exemption would accrue to those retirees with higher pensions or other sources of income. But most of the costs of inflation have been falling on low-income households because of the concentration of rising prices on rent and food. 

Another reason to say no

A second reason to oppose this proposal would compare the net income of retirees to that of current state employees. Why do we want to discriminate against state workers when we have so many unfilled vacancies?  

Let’s compare the situation of that retiree with a $40,000 income with a current state employee (single, no children) with the same income from a salary. All that person’s income is subject to state income taxes, although they also get a smaller standard deduction of just over $12,000. State income tax would be about $1,500. 

Also: State workers don’t get a Social Security check. Instead, Social Security withholds 7.6% of their income to provide benefits for retirees, disabled workers and Medicare for those over 65. Subtract another $3,000.  Another 9% of their salary goes toward the state retirement system to support those same retirees.  Subtract another $3,600. That state worker has a net salary after pension contributions, Social Security taxes and state income taxes that is $8,100 less that his retired neighbor. In addition, state workers do not receive a regular cost-of-living adjustment. They get whatever the legislature decides to give them, which was pretty decent this year but has been nothing in many past years.  Social Security recipients get a regular COLA, which was 8.7% for the most recent year. Given how hard it is for the state to recruit and retain state workers, especially nurses, teachers and prison guards, why do we make the imbalance worse?

There are other objections to this proposal.  For example, reducing state income tax revenues by a series of cuts in the top rate and exempting military pensions also reduces the base on which state aid to city and county governments is calculated, so they get less state aid.  It is particularly hard on counties, which have a lot of shared responsibilities with the state—libraries, roads, the judicial system and health services, just to name a few. 

What, if anything, should we be doing for our retired state employees? Giving them a cost of living adjustment out of the retirement system is out of the question.  The state is on a slow but steady path to ensure that the retirement system is fully actuarially funded by some time in the 2030s. 

A less costly alternative might be to increase the pension exclusion to, say, $13,000 and index it for inflation which are currently in place for other elements of the tax code.  But only if there is some kind of commitment of inflation adjustments for state employees. Fair is fair.

Holley Ulbrich is retired professor emerita of economics from Clemson University. This commentary first appeared in Statehouse Report. Have a comment? Send to:

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