Incidentally, London has a "Freedom Pass" (free transport for retirees), which is funded in the way you describe.

Instead of TfL being forced to take the loss, they are reimbursed by local government cost of the transport.

As an aside, I also take some issue with this pass being completely free to use. In my experience, people end up using it to go a single stop just because it's free, so why not -- which slows bus service for everyone else. I think it should be 20p per journey or something like that.