CRS Reports Deduction for Elderly Fails Equity Tests

                       CRS REPORT FOR CONGRESS

[1] Our tax laws provide certain tax allowances for the elderly. Among the most important is the availability of an additional standard deduction amount allowed to those age 65 years or older. Other special tax allowances are included in other provisions of the law, ¹ such as the preferential tax treatment accorded Social Security and railroad retirement benefits and the favorable tax treatment accorded long-term care expenses. ² Only the additional standard deduction amount for the elderly, however, is reviewed in this report.

[2] Present law provides that individuals are entitled to a standard deduction amount instead of itemizing deductions. In tax year 1999, the standard deduction amounts that taxpayers may deduct from their income are $4,300 if single; $6,350 as head of household; or $7,200 if married and filing jointly. In addition, each married taxpayer is allowed an additional standard deduction amount of $850 if he or she is at least 65 years of age or blind; if both blind and 65 years of age or older they are each allowed two additional standard deduction amounts of $850. (Thus, the total added deduction for a married couple, both of whom are blind and over age 65, would be $3,400.) If single or filing as head of household the additional standard deduction amount is $1,050 for age or blindness, and $2,100 for both. However, the additional standard deduction amount is not allowable for a dependent who is 65 years old or blind. The forgoing amounts are subject to adjustment for inflation. ³

LEGISLATIVE HISTORY AND RATIONALE

[3] In the past, the advocates of special tax provisions for elderly taxpayers have justified special tax concessions based on need. They argued that the elderly have small incomes and are unable to adjust their incomes to increases in the cost-of-living since they no longer work. Thus, it is no surprise that we find the legislative history indicates that the underlying basis of the special tax concessions for the elderly is need: that older persons are not as well off as younger persons who are still working.

[4] In introducing the provision for an additional personal exemption in the 1947 tax bill (which was later vetoed), the House Ways and Means Committee and the Senate Committee on Finance recognized these considerations in their reports on the bill. In the Revenue Act of 1948, ⁴ the additional personal exemption was again provided for based on these considerations. Both the House Ways and Means Committee and the Senate Committee on Finance reported that:

     There is a very heavy concentration of small incomes among

[6] A comprehensive revision of the income tax code was made with enactment of the Tax Reform Act of 1986 (TRA86). ⁷ The revision was designed to lead to a fairer, more efficient and simpler tax system. In order that tax rates could be lowered, the act broadened the tax base by removing the preferential treatment of certain classes of income and expenditures (e.g., capital gains, two- earner wage deduction, personal interest deductions, etc.). This act also repealed the dividend exclusion, the political contributions credit and the provision for income averaging. Both the personal exemption amount and the standard deduction amounts were raised, thus reducing the number of taxpayers who would find it advantageous to itemize their deductions.

[7] Further, the act repealed the additional personal exemption amount for the elderly and/or blind and in its place instituted an extra standard deduction amount for both elderly and/or blind taxpayers. This additional standard deduction amount was combined with the increased standard deduction provided by the 1986 act. ⁸ As noted earlier, both the standard deduction and additional standard deduction amounts (for elderly and/or blind taxpayers) are indexed for inflation.

[8] Higher income taxpayers are more likely to itemize than lower and moderate income taxpayers, who are more likely to use the standard deduction. Thus, a personal exemption has greater value for higher income taxpayers than an additional standard deduction amount. All taxpayers can use a personal exemption whereas an additional standard deduction can be used only by those who forgo itemizing deductions. ⁹ Thus, the Congress was attempting in the 1986 tax act to target the tax benefits to lower and moderate income elderly and blind taxpayers by substituting an additional standard deduction amount for the additional personal exemption amounts permitted those groups under prior law. For tax year 1999, the additional standard deduction amount stands at $850 for an elderly married individual and $1,050 for an elderly unmarried individual. ¹⁰

ASSESSMENT

[9] It may be that the elderly have been singled out for special tax treatment because Americans can relate -- and are related to -- the aged. Tax benefits are frequently available to taxpayers' parents and grandparents and are viewed as one method of enabling relatives to remain independent. Further, younger taxpayers may see this tax benefit as one that they will enjoy in future years. Thus, to the extent that the current benefits will be available to them, they are likely to be supportive of such tax advantages. To the extent that benefits remain the same over generations, any advantages to those now elderly compared with those who are young now (but who will be elderly later) are small.

[10] As noted earlier, advocates for the elderly justify special tax treatment based on need. They argue that the elderly face increased living costs primarily due to inflation. For example, the elderly are frequently faced with increased medical costs that have risen faster than prices on many goods and services. ¹¹ While facing these increase[d] costs the elderly often have age related physical attributes which gives rise to a diminished ability to work.

[11] Nevertheless, the premise underlying the original rationale for the provision no longer holds true. The argument went that the elderly were faced with inflation while their incomes were held flat. Since 1975, Social Security benefits are adjusted annually for cost inflation. Further, to protect the elderly from high medical costs the federal government has established the Medicare Program. Thus, while it is still true that many elderly individuals have low incomes, it is no longer true that the elderly have higher rates of poverty than the general population. Indeed, more children are found to live in poverty than the aged. ¹² Because the provision is not precisely targeted at need, these changing characteristics of the elderly mean that many who are not poor receive the benefit (the following table provides a distribution of those who use this tax benefit by adjusted gross income class).

      DISTRIBUTION BY INCOME CLASS OF THE TAX EXPENDITURE FOR THE

[13] Another targeting issue is presented by those who are not elderly themselves, but provide care for older persons. As previously mentioned, a taxpayer who supports an elderly dependent may not claim the additional standard deduction amount. Many believe that a taxpayer who must incur additional expenses for an elderly dependent has as much justification to claim the additional standard deduction amount as that dependent.

[14] As noted previously, the tax benefit is currently more accurately targeted at need than before the TRA86 changed the extra personal exemption to an extra standard deduction amount. Low-income taxpayers most frequently use the standard deduction while higher income taxpayers are more likely than low-income individuals to itemize deductible items. This is because higher income taxpayers are more likely to own their homes leading to mortgage interest and property tax deductions. Additionally, higher income taxpayers may also owe state income taxes that are deductible in determining federal taxable income. Conversely, it is also true that many of our elderly have paid for their homes, thus, no longer have mortgage interest deductions. However, in general, it remains true that as an additional standard deduction amount, this tax benefit for the elderly is more likely to go to lower or moderate income elderly taxpayers than an itemized deduction. Unfortunately, statistics are not available that break out those that claim the age versus those that claim the blindness additional standard deduction amount. Presumably, most qualify based on age but we lack precise data.

[15] However, even if the tax provision were more precisely targeted and it was only available to the needy, it could still be criticized on equity grounds: it discriminates against other needy taxpayers. One notion of fairness is that the tax system should be based on the ability-to-pay and that ability is based upon the income of taxpayers -- not age. ¹³ Thus, the provision of an "extra" standard deduction amount for age "violates" the principal [sic] of "horizontal" equity: since people with equal incomes will not pay equal taxes if one is young and the other elderly. Further, the original rationale for the provision (as cited earlier in this report) noted that the elderly were "handicapped in an economic, if not in a physical sense". Thus, as but one example, taxpayers with disabling conditions may be in as much need of tax relief. For, just as the elderly are faced with diminished earning capabilities so too are many disabled persons due to their individual impairments. Further, like many elderly, many disabled taxpayers have low incomes.

[16] Congress may review alternatives that would improve the targeting of the provision. The availability of this provision was founded on the taxpayer having attained 65 years of age. In the intervening years, life expectancy has increased. The Social Security program recognized this fact and provided that future retirees will receive full benefits but only at higher age levels. One alternative would be to raise the eligibility age. For example, the Census Bureau reported that total money income of the elderly declines with age. ¹⁴ Thus, to return the program to its original rationale (need and the inability to compete financially with taxpayers still working), age could be correlated to the poverty level to determine a more advanced age at which to provide this tax benefit.

OPTIONS FOR CHANGE

[17] As previously noted, the value of the additional amount is greater for higher than lower income taxpayers. If Congress wanted the provision more focused to benefit lower income elderly then it could be converted to a tax credit with a phase-out range. For example, the child care tax credit amount decreases as income rises. The credit might be made unavailable to higher income taxpayers such as the tax credit for the elderly and permanently and totally disabled. Another alternative would be to investigate a change from a tax-based program to a grant program. Under a grant program, the revenue costs are known and benefits precisely targeted with conclusive rules and regulations. It may be noted, however, that a grant results in taxable income to the recipient unless specifically excluded by statute.

[18] While the goal of a balanced budget has finally been achieved, the reality is that a large debt remains from prior deficit spending. Demographic trends are such that with the nation aging it can be expected that this tax expenditure may rapidly grow in size. The Joint Committee on Taxation estimates that the revenue cost over the five fiscal years of 1999-2003 will be $10.3 billion for those who use the additional standard deductions available to the elderly and blind.

² For more information on this provision, see: U.S. Congress. Joint Committee on Taxation. Present Law and Background on Federal Tax Provisions Relating to Retirement Savings Incentives, Health and Long Term Care, and Estate and Gift Taxes. (JCX-29-99), June 15, 1999. p. 73-80. [http://www.house.gov/jct/x-29-99.htm]

³ For more information on statutory marginal tax rates, personal exemption and standard deduction amounts, see CRS Report RL30007, Individual Income Tax Rates: 1999, by Gregg A. Esenwein.

⁴ Revenue Act of 1948, Public Law 471, 80th Congress, approved April 2, 1948.

⁵ U.S. Congress. House. Committee on Ways and Means. Revenue Act of 1948; Report to Accompany H.R. 4790. Washington, U.S. Govt. Print. Off., 1948. p. 20. (80th Cong., 2d sess., House Report No. 1274.) And also U.S. Congress. Senate. Committee on Finance. Revenue Act of 1948. Washington, U.S. Govt. Print. Off., 1948. p. 21. (80th Cong., 2d sess., Senate Report No. 1013.)

⁶ Internal Revenue Code of 1954, Public Law 591, 83rd Congress, approved August 16, 1954.

⁷ Tax Reform Act of 1986, Public Law 514, 99th Congress, approved October 22, 1986.

⁸ The higher standard deduction amounts were effective one year earlier (1987) for elderly or blind individuals.

⁹ The 1986 act provided that beginning in 1988, the personal exemption is reduced (or phased out serially) for high-income taxpayers. The phaseout levels are adjusted for inflation.

¹⁰ The additional standard deduction amount for married taxpayers increased from $600 to $650 in 1990, $700 in 1992, $750 in 1994, $800 in 1996 and $850 in 1998. The amount for single taxpayers rose from $750 to $800 in 1990, $850 in 1991, $900 in 1992, $950 in 1994, $1,000 in 1996 and $1,050 in 1998.

¹¹ It should be noted that benefits under Medicare are not taxed.

¹² See U.S. Department of Commerce. Economics and Statistics Administration. Bureau of the Census. Aging in the United States -- Past, Present, and Future. Available on the internet at [http://www.census.gov/population/www/socdemo/age.html#elderly].

¹³ Vertical equity is the relative tax burden borne by individuals at different income levels. Vertical equity requires that taxpayers with large incomes pay more in taxes than taxpayers with a small income.

¹⁴ See U.S. Department of Commerce. Bureau of the Census. 65+ in the United States; Current Population Reports: Special Studies. By Frank B. Hobbs with Bonnie L. Damon. Available on the internet at [http://www.census.gov/prod/1/pop/p23-190/p23-190.html].