Health Care Costs, Taxes, and the Retirement Decision: Conceptual Issues and Illustrative Simulations

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Soaring health costs are squeezing government and household budgets, and rising public spending is likely to boost future tax burdens. This study considers how rising tax burdens and out-of-pocket health care costs will affect retirement decisions. The study compares projected retirement income for prototypical workers under two sets of assumptions about future tax and health care burdens. The high-cost scenario assumes that health care costs grow at the rapid rate projected by the Medicare trustees and that effective tax rates rise dramatically as Congress allows the 2001-2003 tax cuts to expire and does nothing to restrain tax-bracket creep, the growth of the Alternative Minimum Tax, or the increase in the share of households with taxable Social Security benefits. The low-cost scenario assumes that tax burdens remain at their approximate 2000 levels and that health care costs remain constant in real terms between 2000 and 2030.

The results show that a moderate-income couple would have to delay retirement by about 2.5 years to receive as much annual retirement income under the high-cost scenario as under the low-cost scenario. The low-income couple would have to work an additional 2.4 years to offset income lost from higher taxes and health care costs, and the high-income couple would have to work an additional 2.8 years. Results are similar for single adults, except that low-income single adults are not affected much by the high-cost scenario, because they would not pay federal income taxes and most of their health costs would be covered by Medicaid.