Over the next two decades, a significant U.S. demographic shift will occur: By 2035, the U.S. Census Bureau projects that the number of people age 65 and over will outnumber those under the age of 18 for the first time in the nation's history. This shift will exacerbate generational dependency, creating economic, fiscal, and social challenges for U.S state governments.

S&P Global Ratings considers generational dependency a long-term social credit factor that may result in state credit deterioration. As the population ages, people leave the workforce, placing a larger share of the burden for funding government services and economic growth on younger generations. However, demographic destiny is not predetermined. Prudent fiscal management of coming demographic headwinds will ultimately dictate the direction of state credit quality.

One way to measure the magnitude of this generational shift is to look at the "old-age dependency ratio" or the number of persons age 65 and over divided by the labor force (age 15 to 64) as defined by the OECD. The map shows the projected trend in old-age dependency ratios over the next two decades based on IHS Markit Data. States are categorized based on how much their generational dependency is expected to increase: high--faster than 75% of all other states; moderate--the middle 50% of all states; and low--slower than 75% of all other states.

Chart 1

As part of our U.S. State Ratings Methodology, we use a broader age dependency ratio calculated by the U.S. Census Bureau in our analysis to assess a state's demographic profile. We believe that the structure and growth characteristics of a state's population base provide critical information about revenue-generating capability as well as the costs of providing services and infrastructure. By examining the old-age dependency ratio in this report, we are attempting to isolate the effects of aging on states and regions.

All regions of the U.S. will be affected by population aging as every state's old-age dependency ratio will increase. Across the four Census regions, more acute credit risks present themselves. Demographic trends in some regions translate to lower economic growth and future budget stress (For more information see our reports, "U.S. States Are Showing Their Age: How Demographics Are Affecting Economic Outlooks," published Sept. 25, 2018 on RatingsDirect and "U.S. States May See Negative Revenue Effects From Aging Demographic Trends," published Feb 14, 2019). As the working-age population declined in the Northeast and Midwest, economic growth fell below that of the U.S as a whole. The South and West fared much better, with greater increases in their working-age population. Over the long term, IHS forecasts the South and West will continue to see working-age population growth at the expense of the Northeast and Midwest. The result will be greater economic growth in states and regions with an increasing working-age population.

Table 1

Nonetheless, all states will face future threats from a potentially changing fiscal federal relationship. Supporting an elderly population is more expensive than caring for a younger one. Primary funding of key retirement security programs--like Medicare and Social Security—fall to the federal government with aging-related spending forecasted to consume an increasing share of the federal budget. The Congressional Budget Office noted in its 2019 outlook that mandatory spending for people age 65 or older grew from 5.8% of GDP in 2005 to 7.5% in 2018 and projected that its share would grow to 9.8% in 2029. Retirement security and quality of life during old age are a national social issue that, in our opinion, is likely to pressure state budgets. As mandatory old-age-related spending consumes more of the federal budget, future funding mandates may be passed down to state governments.

National Generational Dependency Is Increasing For The Foreseeable Future

The old-age dependency ratio tells us how many retired individuals a workforce has to sustain. Lower ratios are generally viewed positively, associated with higher levels of economic growth and more active individuals contributing to tax revenues. Historically the U.S. has been able to maintain a level old-age dependency ratio. As the baby boomer generation retires, the older generation's dependency on younger ones is projected to significantly increase over the next 30 years.

Chart 2

Common demographic trends to offset an aging population include natural population replacement (births minus deaths) and international in-migration. However, in the U.S., these equalizers have been declining for some time (see chart 2), intensifying the increase in the dependency ratio. Reversing these declines is one area that governance may address. Policies to incentivize child birth or alleviate the costs of child rearing and promoting in-migration have been considered by a number of states and are likely to gain more traction.

Chart 3

All states will see increases in generational dependency as the population ages, birth rates decline, and international immigration lessens.

2020, we estimate only three states will have an old-age dependency ratio above 33.3%. By 2040, the number of states with an old-age dependency ratio above one-third is projected to increase to 37. The overall effect of rapidly rising dependency ratios will vary by region as some are having success in diversifying economies and attracting working-age adults.

Chart 4

The Northeast's Aged Medicaid Enrollment Pressures Future State Budgets

An aging population correlates with increasing medical costs. People are living longer, advanced medical technologies are getting more expensive, and health care costs tend to peak late in life. While the federal government provides most funding for retiree health care through Medicare, substantial costs can come out of pocket and an increasing number of low-income seniors are enrolled in Medicaid.

Aged individuals made up only 10% of Medicaid enrollment in fiscal year 2013 (the most recent year available), yet accounted for 23% of program spending. From 2007 to 2013, aged Medicaid enrollment grew 456,000 with a compounded annual growth rate of 1.5%. With increasing costs tied to health care, an aging population, and the need for financial security during retirement, it is likely the aged component of Medicaid enrollment will increase and become a larger share of total program spending.

Chart 5

States contribute to a share of Medicaid expenditures with the federal government reimbursing them for a portion based on a Federal Medical Assistance Percentage (FMAP). Each state's FMAP is primarily based on per capita income along with other criteria. Due to the high levels of wealth in the Northeast, a number of the states in the region (e.g., Connecticut, Massachusetts, New Hampshire, New Jersey, and New York) have an FMAP of 50%, the lowest level allowable by law.

Unfortunately, states in this region also have an above-average enrollment of aged individuals covered by Medicaid (see table 2). A relatively high cost of living and waning economic growth in the region will likely lead to additional increases in aged Medicaid enrollment there. As health care costs continue to rise while people live longer, state spending on Medicaid will only increase. State share of Medicaid already consumes a large portion of Northeast states' budgets, with New York's budget contributing nearly 25% of all state expenditures to the program.

Table 2

We view funding to the states for Medicaid as the greatest federal influence on state credit (see "U.S. States 2020 Sector Outlook: Finding Balance in Today’s Lower-For-Longer Economy," published Jan. 6, 2020). Outside of concerns around funding Affordable Care Act (ACA) expansion, aging demographics are likely to place a strain on the program and increase costs.

As The South's Population Continues To Grow, Economic Diversification Is Key To Rating Stability

The South has benefited from an influx of working-age adults that has offset increases in retirees, thereby slowing the region's generational dependency growth. The region was first for net domestic migration in 2018 as Florida, Texas, North Carolina, and South Carolina were among the top five states for net domestic migration nationally. In recent years, large technology and financial services firms have created new offices or second headquarters in smaller, yet growing, metropolitan statistical areas (MSAs) away from the coasts. Table 3 shows the fastest-growing MSAs with a current population over 1 million and, not surprisingly, a majority are in the South.

Underscoring the region's demographic growth is Florida. The state, often lauded as a destination for retirees, is expected to maintain a stable old-age dependency ratio and be among the slowest-increasing ratios over the next 20 years. Population growth, through in-migration, has been one of Florida's main economic factors and has historically exceeded the U.S. average.

While the region has undergone significant economic expansion, the South was disproportionately affected by the last economic recession. The region's concentration in mining and manufacturing left areas with high local unemployment levels as housing wealth significantly diminished. Continued economic diversification will be a key component for the South's credit stability. Should a downturn occur and unemployment significantly increase, states in the region with aged populations may find it difficult to maintain budgetary balance.

Table 3

While Texas is the nation's largest producer of crude oil and natural gas and energy-related industries remain a central component of the state's economy, we have observed shifts toward diversification in recent years. In our opinion, its economy now more closely resembles the national economy. We believe that the gradual diversification has been spurred largely by two increasingly prominent sectors in the state's economy: technology and the service industries. Population growth in the Austin-Round Rock MSA, for example, has been fueled by high-technology research and development and manufacturing. Houston, although still dependent on energy-related industries, has seen rapid expansions in health care and business services, while the Dallas and Fort Worth MSAs are leading transportation and telecommunications centers.

Chart 6

For regions experiencing slower growth, particularly if there are additional vulnerabilities like tariff-affected jobs, a national or regional economic slowdown could generate a more pronounced effect. Demographic changes can have a similarly dampening effect on local economies, and can also shift the priorities and funding sources of local governments (see "U.S. Local Government 2020 Sector Outlook: A Precarious Balance of Stability and Uncertainty," published Jan. 7, 2020).

Chart 7

Migration Trends And Economic Profiles Are Likely To Increase Midwest Generational Dependency

Within the next 20 years, every state in the Midwest except North Dakota is projected to have an old-age dependency ratio exceeding one third as regional employment growth is limited and current residents age-in-place. The hollowing of America's middle has been a national concern as younger residents leave rural areas and an older population remains behind.

Over the past two decades, a decline in manufacturing employment has had a significant effect on the region. We estimate an approximate net loss of 1.4 million manufacturing jobs in the Midwest from 2000 through 2019. In our opinion, the region is unlikely to see a significant resurgence in manufacturing employment.

Chart 8

Agriculture states in the region are also likely to see waning economic growth. While Nebraska has exhibited very little cyclicality compared to the nation, it now lags national income levels and is consistently below the U.S. in terms of job growth. We view an increasing dependent-age population and changes in the state's demographic profile as a potential pressure to state spending over the long term related to education, health care, and social service programs.

Like the Northeast, the Midwest has seen substantial out-migration over the past two decades. However, the Northeast was buoyed by an influx of residents to New York City, which offset out-migration elsewhere. rom 2000-20018, the Northeast's net migration was about one-third less than the Midwest. Michigan is projected to have the nation's largest increase in its old-age dependency ratio as net in-migration over the past two decades has been negative and natural population replacement declines.

Chart 9

Despite the region being home to Chicago, the nation's third-most populous city, both it and state of Illinois have underperformed economically, reflecting weak demographic trends. For 2019, Illinois' population contracted for a fifth consecutive year and in 2018, Chicago was one of the worst of all MSAs in the U.S. for out-migration. However, despite the city's sluggish demographic and tax base growth, it remains an attractive location for corporate expansions and relocations, helping stabilize the local economy.

Aging-In-Place Will Exacerbate Housing Affordability Challenges In The West As It Keeps Homes Off The Market

Low unemployment, coupled with a "back to the city" movement, is pushing some people out of once-accessible housing and into homelessness. While the luster of major U.S. cities is not likely to go away anytime soon, affordability concerns in some of the nation's cities may affect regional long-term growth (see "U.S. Municipal Housing 2020 Sector Outlook: The Foundation Remains Stable," published Jan. 13, 2020). S&P Global Ratings is monitoring the cost of housing and its effects on economic growth nationally. Our latest article on this issue, "Home Is Where The Funding Is: West Coast Housing Issuers And The Recent Capital Flow" (published Oct. 10, 2019), highlights the unprecedented commitments of capital in the West to address housing affordability.

While growth in California's old-age dependency has slowed in recent years due to an influx of working-age adults, we believe certain structural features of the state's economy could undermine its potential resilience. For example, notwithstanding that California boasts strong income and wealth indicators, it's also plagued by an above-average poverty rate and an above-average portion of its population on Medicaid (about one-third of the state's population). After accounting for the cost of living, the state's poverty measures look even worse. Nowhere is this more evident than in its real estate market, where a chronic shortage of affordable housing, especially in its large MSAs, undercuts the state's business climate.

In Denver, Colo., a large influx of residents has pushed home prices up. The area has seen some of the highest growth in home prices in the U.S., which has led the city to focus extensively on developing and promoting affordable housing for residents. To accomplish this, it increased the sales tax on retail marijuana to 5.5% from 3.5% in October 2018. All in, Denver expects to spend $30 million per year on affordable housing, creating 6,000 new units over the next five years, in part through a partnership with Denver Housing Authority.

Chart 10

As the West remains an attractive destination for retirees, national aging is another headwind likely to pressure housing costs upward. A study by FreddieMac found that aging-in-place reduces home inventory on the market, contributing to higher prices in recent years. According to the study, aging-in-place is responsible for 1.6 million houses held back from the market as of 2018, about one year's typical supply of new construction. In our opinion, new technology improving the ability to age-in-place is likely to increase the number of existing homes left off the market and thereby contribute to higher home prices.

Table 4

Related Research

• Global Aging 2016: 58 Shades of Gray, April 28, 2016
• U.S. States Are Showing Their Age: How Demographics Are Affecting Economic Outlooks, Sept. 25, 2018
• Through The ESG Lens: How Environmental, Social, And Governance Factors Are Incorporated Into U.S. Public Finance Ratings, Oct. 10, 2018
• U.S. States May See Negative Revenue Effects From Aging Demographic Trends, Feb. 14, 2019
• When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason, March 28, 2019
• An Influx Of Capital Is Set For West Coast Housing Affordability Challenges, July 29, 2019
• U.S. State Pension Reforms Partly Mitigate The Effects Of The Next Recession, Sept. 26, 2019
• Fifteen Largest U.S. City Pensions See Modest Gains In 2018, But Recession Risk And Rising OPEB Cost Challenges Persist, Sept. 23, 2019
• Environmental, Social, And Governance: Long-Term Credit Challenges Facing U.S. State And Local Governments In Coal-Producing Regions, Sept. 25, 2019
• Home Is Where The Funding Is: West Coast Housing Issuers And The Recent Capital Flow, published Oct. 10, 2019
• U.S. Not-For-Profit Senior-Living Sector's Stability Is Built On Favorable Demographics, Strong Demand, Oct. 31, 2019
• U.S. States 2020 Sector Outlook: Finding Balance in Today’s Lower-For-Longer Economy, Jan. 6, 2020
• U.S. Local Government 2020 Sector Outlook: A Precarious Balance of Stability and Uncertainty, Jan. 7, 2020
• U.S. Municipal Housing 2020 Sector Outlook: The Foundation Remains Stable, Jan. 13, 2020