HEARING ON SOCIAL SECURITY’S FINANCES
SUBCOMMITTEE ON SOCIAL SECURITY
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
June 23, 2011
Printed for the use of the Committee on Ways and Means
COMMITTEE ON WAYS AND MEANS
KEVIN BRADY, Texas
XAVIER BECERRA, California
LLOYD DOGGETT, Texas
SHELLEY BERKLEY, Nevada
FORTNEY PETE STARK, California
C O N T E N T S
Advisory of June 23, 2011 announcing the hearing
Thomas A. Barthold
Chief of Staff, Joint Committee on Taxation
Stephen C. Goss
Chief Actuary, Office of the Chief Actuary, Social Security Administration
Texas Retired Teachers Association, on behalf of Coalition to Preserve Retirement Security
Research Fellow, American Enterprise Institute
Mark J. Warshawsky, Ph.D.
Former Assistant Secretary for Economic Policy, U.S.Department of the Treasury
Andrew G. Biggs, Ph.D.
Resident Scholar, American Enterprise Institute
House of Representatives,
Subcommittee on Oversight,
Subcommittee on Social Security,
Committee on Ways and Means,
The subcommittee met, pursuant to notice, at 2:04 p.m., in Room B‑318, Rayburn House Office Building, Hon. Sam Johnson [chairman of the subcommittee] presiding.
[The advisory of the hearing follows:]
*Chairman Johnson. Thank you all for being here. I want to apologize to our witnesses and audience for the delay due to the vote, and I thank you for your patience. This meeting will come to order.
I want to thank you all for your testimony ahead of time. As we heard from the public trustees at our June the 3rd hearing, Social Security revenues will cover only 77 percent of the benefits by 2036. Congress needs to act, and the sooner we do so, the sooner we can protect those who are most vulnerable, along with current retirees and those nearing retirement. And for younger workers and families we have a responsibility to provide certainty about the future of their Social Security.
To that end, I was heartened to learn of the deliberations of AARP’s volunteer board, and welcome their acknowledgment that Social Security will be unable to pay benefits promised in the future, and how the program needs to be strengthened for generations to come.
Today we will learn more about Social Security’s current revenue sources, proposed changes to those sources, and their impact on Social Security workers, beneficiaries, and economic growth.
Since its beginning, Social Security has been a program primarily financed by workers for workers. Workers’ hard‑earned payroll taxes fund the majority of the benefits Social Security pays out each year. It is important to point out, as well, that the number of workers paying into Social Security has been steadily declining over the years. In 1950, for instance, there were 16‑1/2 workers for each beneficiary. Today, just 2.9 workers, and in 14 years, 2.3 workers per beneficiary.
You are shaking your head; you agree.
*Chairman Johnson. In 1935, the tax rate for employers and employees each was just 1 percent on earnings, up to $3,000 a year. How far we have come. Congress has raised the payroll tax 14 times since then. Today the tax rate is 6.2 percent for employees and employers, for a combined 12.4 percent.
The amount of earnings subject to payroll tax, however, known as the taxable wage base, has also grown over time. In 1935 the taxable wage base was $3,000. Over the life time of the program, the taxable wage base has been statutorily increased by Congress 10 times. In 1972, Congress passed legislation that increased the base automatically to reflect the growth in average wages. However, soon afterwards, Congress increased the wage base even further over a number of years.
Annual tax increases have generally been in autopilot since 1982. Since then, the wage base has increased 26 times from $32,400 to its current level of $106,800. Probably go up again this year, too, you all think?
But despite these tax increases, Social Security is still in trouble. Not enough young workers are paying this tax to sustain the Baby Boomer wave of retirees leaving the workforce and drawing benefits at the rate of 10,000 a day for the next 19 years. Clearly, we can’t tax our way to sustainable solvency.
And, as we consider the program’s financial state, we can’t lose sight of the fact that throughout the history of the program, Congress has also increased benefits beyond the ability of the program to pay for them in the long run.
The challenge Congress now faces goes beyond just rebalancing Social Security’s finances . With chronic unemployment, falling incomes, and so many young workers unable to start their careers, nothing we do should make it harder for Americans to find good‑paying jobs.
I am sure, if you ask any ordinary citizen, what is vitally important to them, you will likely hear, “good paying jobs.” They worry America is falling behind, and that their children’s futures will be dictated by foreign predators. Americans want and expect a balance between creating a new and better economy for their children and caring for their elders.
That is why, as we look ahead, Social Security must be what its founders intended: a program that lives within its means. Americans want, need, and deserve nothing less. We must do this for the American people. And I am confident that, by working together, we will.
Mr. Becerra, would you care to make a statement?
*Mr. Becerra. Yes, Mr. Chairman, I would. Mr. Chairman, thank you very much. Thank you for holding this hearing today.
I would like to begin, first, by acknowledging something the chairman said, that we are looking at somewhere around 2036 before Social Security will face a situation where it doesn’t go broke, it won’t go bankrupt, but it will have a challenge in providing the benefits that Americans today expect to receive when they retire in that year of 2036.
I think that is an important acknowledgment, Mr. Chairman, because too often the conversation ‑‑ or should I say the debate ‑‑ on Social Security is one where some would discount the money that Americans, on a daily basis, are contributing to Social Security through a tax, the FICA tax, that they contribute to the Social Security system and the trust fund.
The more we acknowledge that today Social Security is paying benefits on time and in full, and has always done that for more than 75 years, and that it will continue to do so for another good 20‑some‑odd years, it becomes very important. Because, unlike the rest of the Federal Government, which is in fiscal crisis, Social Security today goes forward.
Remember, as well, that, at the same time that Social Security has never missed a payment, most Americans a couple of years ago were afraid to look at their 401(k) or IRA statements, because they saw what was happening to their private savings and their pension funds. It becomes very important for us to have a conversation about Social Security that talks about the facts on the ground.
And, Mr. Chairman, I think many people will have to acknowledge that the facts are very stubborn things. They don’t lie. And the reality is that today we have a system that has never failed the American public. And I don’t believe anyone in this chamber would like to see Social Security fail. And that is why I do believe, Mr. Chairman, like you, that there is a chance for some bipartisan cooperation in dealing with the future challenges that Social Security will face, much because of the Baby Boom generation, but many of them simply because of the fact that America, like every other country, continues to change.
The challenge has nothing to do with any sneaky numbers or broken magic on the part of Social Security to pay benefits. It is a very straightforward system. You put something in, and we’ve been able to guarantee that we put something out to pay you.
I actually disagree with you on one point, Mr. Chairman. Social Security is not overly generous. Social Security hasn’t gotten too big when it comes to what it provides to Americans. The benefits today are very modest. And most seniors have very limited incomes. The average benefit for a senior today is somewhere around $14,000 a year. Among senior households, the median income is only about $24,000. So when you are talking about a household that may have more than one senior, you are still only looking at about $24,000.
One out of every three beneficiaries under Social Security depends on that Social Security paycheck to provide virtually all of their income. And less than half of seniors in America have a pension or a savings plan from their work. Only the wealthiest one‑fifth of seniors in this country have any significant income from assets.
Keep in mind, as I said before, that were it not for Social Security, in 2008 all those folks who are ready to retire in this country probably were looking at a collapse of their IRA and their 401(k). At least a third of the value of those privately held assets had disappeared.
And that is why, Mr. Chairman, it does disturb me that some of the proposals we see from my Republican colleagues call for nothing but cuts to the benefits in Social Security, whether it is the privatization plan presented by Mr. Sessions, a member of the leadership in the House Republican Conference, or whether it is the plan of the chairman of the Budget Committee, Mr. Ryan, who has had plans in the past to privatize the system, and whose budget calls for a fast‑tracking on future cuts of Social Security, or whether it was the recent proposal by Senator Hutchinson to reduce the COLA by one percent at a time when seniors haven’t received a COLA increase in two years, these are all cuts.
And at a time when all Americans are suffering through difficult economic times, I don’t believe we want to see our seniors go back to the 1930s when, what was it, some 3 out of every 4 that would retire retired into poverty.
And so this is a fabulous program that has worked well. But demographics will make it more challenging in about a quarter of a century. And rather than wait a quarter of a century, we should tackle it now. And that is why, Mr. Chairman, I look forward to working with you and all of our colleagues on this committee to try to present to our colleagues and the rest of the House a proposal in the future that can really take us a long ways in making sure that Social Security will once again be there for all Americans, as it has for more than 75 years.
I yield back.
*Chairman Johnson. Thank you. Just know that you and I disagree on how the money is being counted, and there are a lot ‑‑
*Mr. Becerra. I think you have made that very clear, Mr. Chairman.
*Chairman Johnson. There are a lot of IOUs out there in the Social Security trust fund that have to be paid from the general revenue.
*Mr. Becerra. China, Japan, and every major corporation in America knows the same thing, and they are waiting to be paid, as well.
*Chairman Johnson. I know. Before we move on to our testimony today, I want to remind our witnesses to limit your oral statements to five minutes, if you can.
Without objection, all the written testimony will be made part of the permanent record.
We have one panel today, and our witnesses who are seated at the table are Tom Barthold, Chief of Staff, Joint Committee on Taxation; Stephen Goss, Chief Actuary, Office of the Chief Actuary, Social Security Administration; Tim Lee, Texas Retired Teachers Association, on behalf of the Coalition to Preserve Retirement Security ‑‑ we have had some arguments over that one, too ‑‑ Alex Brill, research fellow, American Enterprise Institute; Mark Warshawsky, Ph.D., former Assistant Secretary for Economic Policy, U.S. Department of the Treasury; and Andrew G. Biggs, Ph.D., resident scholar, American Enterprise Institute.
I thank all of you for being here today.
And, Mr. Barthold, you are recognized for five minutes.
STATEMENT OF THOMAS A. BARTHOLD, CHIEF OF STAFF, JOINT COMMITTEE ON TAXATION
*Mr. Barthold. Well, thank you, Chairman Johnson and Mr. Becerra. Your subcommittee staff had asked if my staff and I could prepare background discussion of the Social Security tax base, and that is what was provided to you and your staff in our publication JCX-36‑11. I will take my couple of minutes here to summarize the high points, many of which you actually introduced in your opening remark.
The Social Security and Medicare trust funds are primarily financed by payroll taxes on covered wages. The payroll taxes include the FICA tax, Federal Insurance Contribution Act, and the SECA tax, the Self‑Employed Contributions Act. There is also, for the Medicare trust fund, an additional hospital insurance tax. And, in addition, funds are contributed to both the Medicare and Social Security trust funds from an income tax on certain included Social Security benefits.
I will discuss first, in brief, the payroll taxes. FICA imposes taxes on both employers and employees, based on an amount of wages paid to the employee during the year. It is composed of two parts. The OASDI tax equals 6.2 percent of covered wages, up to the maximum wage base, $106,800 for this year, as noted by the chairman. And there is an HI tax equal to 1.45 percent of covered wages. The employee’s tax is generally equal to the amount of tax imposed on the employer.
Likewise, the SECA tax has two components, and the rate of the SECA tax is set to equal the combined rates of the employee and the employer under the FICA tax. So, under the OASDI component, the current rate of tax is 12.4 percent on self‑employment income, up to the Social Security wage base of $106,800. And under the HI component, the tax rate is 2.9 percent on all self‑employed employment income.
Now, I should note that, for the current year, there is a two percentage point reduction in the OASDI rate to 4.2 percent, both for the employee portion of FICA, as well as for SECA. This was enacted as a provision in late 2010.
The present law ‑‑ as noted by the chairman, the present law wage base is indexed each year, based on growth in average wages in the national economy. Now, under these taxes the law provides certain exceptions from the wage base for certain types of employment and certain types of remuneration.
One type of employment exempted from Social Security tax is based on categories of workers who are covered under alternative retirement systems. These include certain state and local government employees, employees of the Federal Government, and workers whose compensation is subject to the Railroad Retirement tax system.
A second type of exempted employee involves workers with religious beliefs whose beliefs preclude participation in the Social Security system.
A third type of exempted employment is wages to students. There has been a recent ‑‑ I will note that there is a recent dispute resolved by the Supreme Court in the so‑called Mayo case. The Supreme Court in that case upheld an IRS regulation providing that medical residents are not students, and, therefore, are subject to Social Security taxes, where wages paid to other students are exempt.
Now, even when a worker’s type of employment is covered by the Social Security, certain types of remuneration paid to the worker are not subject to that tax. This generally follows income tax exclusions. Examples of such exempted compensation include employer‑provided retirement benefits and employer‑provided health benefits. There are similar elective contributions for health benefits through health FSAs, which are also excluded from both the income and Social Security taxes.
In general, the FICA taxes apply to workers who are employees. The SECA taxes apply to workers who are self‑employed or independent contractors. One ongoing issue regarding payroll tax liability is the determination of whether a worker is properly treated as an employee or as an independent contractor. If a person is an employee, the responsibility for reporting and withholding FICA rests with the employer. If you are an independent contractor, then reporting and withholding rests with the worker. This determination shifts the burden of compliance, not the underlying liability.
I also noted another component of funding for the trust funds is the income tax. Individuals with incomes above certain thresholds must pay income tax on a portion of their Social Security benefits, and the revenue raised from the Social Security benefits finance ‑‑ from the taxation of Social Security benefits, excuse me ‑‑ finances both the Social Security and the Medicare trust funds.
And, with that, I will conclude my brief summary, and be happy to answer any questions that the Members might have.
[The statement of Mr. Barthold follows:]
*Chairman Johnson. Thank you, I appreciate that. I want to welcome our newest member, Mr. Kenny Marchant, from the great state of Texas, as a member of this committee. Glad to have you aboard.
*Mr. Marchant. Glad to be here.
*Chairman Johnson. Stephen Goss, chief actuary, Office of the Chief Actuary, Social Security Administration. You are recognized for five minutes, sir.
STATEMENT OF STEPHEN C. GOSS, CHIEF ACTUARY, OFFICE OF THE CHIEF ACTUARY, SOCIAL SECURITY ADMINISTRATION
*Mr. Goss. Thank you very much, Chairman Johnson, Ranking Member Becerra, members of the subcommittee. It is really a pleasure to be here, and thank you for the invitation.
I would like to take these couple of minutes to sum up the written testimony that I submitted, but also to put in perspective the history and the expectations for the future of what the costs of Social Security are going to be, and what they mean for us, to make sure that the system is set up properly for the future.
Chairman Johnson, you quite rightly pointed out some of the very interesting facts of Social Security, about the incredibly fundamental ratio of numbers of workers for every beneficiary that we have to support the system.
And we should keep in mind about Social Security, that when the first monthly benefits were paid in 1940, we had somewhat over 40 workers for every beneficiary. And the reason for that was clear; we were taxing virtually all the workers, starting right off the bat, but the only people in 1940 who could get monthly benefits were people who had worked for at least 2 years in the years 1937, 1938, or 1939. Not many very, very old people had worked for two years in that period.
So, it was a long time, not until about 1975, until the system actually matured, and we reached the point where we reached a rather stable level of 3.3 workers per beneficiary. We stayed at that level from 1975 until about 2008.
As you mentioned, Chairman Johnson, after 2008, starting around 2010, the recession has gotten a head start on moving in the direction of having a drop in the number of workers per beneficiary.
It is important to understand why that is happening. It is happening in part because of the Baby Boomers moving over from the ages which have been working ages over the next 25 years, into the ages in which they will be retirees. But, actually we wouldn’t even call them the Baby Boom bulge if, in fact, they had all had 3.3 kids themselves as people in 1946 through 1965 did.
Historically, birth rates have been at about 3 children per woman, especially if you look at the number of children surviving to age 10. Between the end of the Baby Boom period and the mid‑1970s, we actually had a drop in the birth rate in this country from an average of 3 kids down to an average of 2 children. If we are going to support elders in our country, and they all had three kids in the past, and now in the future they are all going to have two kids, that really is a fundamental shift.
The point is that this isn’t just a matter of people living longer. There is some of that. The fundamental change over the next 25 years, in the cost of the system relative to GDP, relative to payroll, and in the number of workers per beneficiary, is really due to the drop in the birth rate. It is not that we are going to do anything about this change, but it is important for understanding how we got there.
The implication of this drop in the birth rate is really quite striking. As both the chairman and the ranking member mentioned, we are in a situation where we are going to have a drop in the number of workers per beneficiary, and this is going to cause the cost of Social Security, of the benefits that are scheduled now, to change from about 4.3 percent of GDP ‑‑ which it has been for decades — to rise up to about 6 percent of GDP.
The fundamental question before you all, as our elected representatives is, “Where do we want to go? What do the American people want to do? Do they want to have the kind of benefits that are scheduled in current law, and raise the revenue up from the 4.5 percent of GDP that is scheduled in current law now up to 6 percent? Or, do they want to keep revenue at 4.5 percent of GDP and lower benefits?” There is really a fundamental choice between raising revenue by a third, reducing the scheduled benefits by a fourth, or some combination of those two.
In my position ‑‑ I am sure also for Tom Barthold and probably most of us ‑‑ we are not in a position to tell you what really makes the most sense. But these are the choices that are before you on behalf of your and all of our constituents.
Let me speak a little bit about the very near term situation for Social Security. There has been a lot of talk about the year 2010, in which we had the first year ‑‑ for quite a while, since 1972 ‑‑ in which we had more cost for the system than we had taxes coming in. Now, the trust fund is still growing, because interest more than exceeded the amount of shortfall we had in taxes, and that will continue until 2023. But we did have of taxes in the year 2010, and this is what a recession looks like; we have more people coming and getting benefits, fewer people working.
We are projecting now for the years 2012, 2013, and 2014, that we will have cash flow deficits ‑‑ that is, cost exceeding the taxes in the system, by a little less than 20 billion a year, where in the prior trustee’s report, in 2010, we were projecting a little bit less than a $10 billion‑per‑year surplus.
That kind of a swing is significant. But for a $700 billion per year cost program and a federal budget where we are running deficits on the order of $1 trillion per year, that kind of swing was probably not all that traumatic.
So, we are facing a situation over the next 25 years in which we are going to have this dramatic shift. We are going to be having increasing cost, we are going to have to find a way to get there. The trust funds do stand as the cushion to give us the authority to be able to augment the taxes that we have coming in to be able to pay scheduled benefits, as you both mentioned, until 2036.
But the fundamental question that is before us is, “What do we do thereafter?” Are we going to raise taxes? Are we going to lower benefits? One thought that I would really want to leave you with is that we should not analyze a change in taxes or a change in benefits from just one perspective.
For example, if we decided that, in order to continue paying the full benefits, even through 2036, we want to raise taxes during that period to have more money coming into the trust funds, what that will mean is that we will dip into the trust funds less. If we raise taxes and have more revenue coming to pay benefits during that period, that means that we will have less spending down of the trust funds and ‑‑
*Chairman Johnson. Can you close it down? Your time has expired.
*Mr. Goss. Okay, sorry. If we have more taxes, we will have less borrowing from the public. Both of those have economic implications. We should not look at an increase in taxes, just as the implication of taxes, but also what that means in terms of borrowing less from the public.
I have submitted a number of individual provisions that have been considered. I am hoping in the questions we might be able to get into some of those.
[The statement of Mr. Goss follows:]
*Chairman Johnson. Thank you, sir.
*Mr. Goss. Thank you very much.
*Chairman Johnson. Tim Lee, Texas Retired Teachers Association, on behalf of the Coalition to Preserve Retirement Security. You are recognized for five minutes.
*Mr. Lee. Thank you very much.
*Chairman Johnson. Are you from Texas?
*Mr. Lee. Yes, sir.
*Chairman Johnson. Where do you live?
*Mr. Lee. I live in Austin.
*Chairman Johnson. Okay.
*Mr. Lee. Yes, sir.
STATEMENT OF TIM LEE, TEXAS RETIRED TEACHERS ASSOCIATION, ON BEHALF OF COALITION TO PRESERVE RETIREMENT SECURITY
*Mr. Lee. Chairman Johnson, Ranking Member Becerra, and distinguished members of the subcommittee, my name is Tim Lee, and I am the executive director of the Texas Retired Teachers Association. I am testifying today in my capacity as a board member of the Coalition to Preserve Retirement Security, specifically here to talk about the issue of mandating Social Security coverage with public workers.
Over the years some have recommended bringing all public workers into the Social Security program. However, mandating that all newly hired public workers must participate in the Social Security system would create significant new cost pressures for the affected state and local government jurisdictions, while providing only minimal benefit to the program.
These jurisdictions, with their own long‑standing defined benefit retirement plans, would have to make difficult choices. Adding an additional 6.2 percent payroll tax per worker to the benefit cost of public employers would almost certainly result in cut‑backs to their existing defined benefit plans, cuts in government services and/or increases in taxes or fees to absorb the added costs. The disruption that would likely occur for these public jurisdictions and their workers seems a high price to pay for adding an estimated two years of solvency to the Social Security program.
It is estimated that mandatory Social Security coverage would cost the affected states and localities $44 billion over 5 years. The additional financial burden, which will impact all 50 states to one degree or another, could be an insurmountable budgetary hurdle, particularly during these very difficult days of huge revenue shortfalls hitting virtually every state.
In Texas, for example, our state legislature has finished its regular session and is now in special session. The regular session was particularly difficult, as we all struggled with a budget reduction for the biennium that exceeded $15 billion. The state budget reduction has hit public sector ‑‑ particularly our public schools ‑‑ very hard. Tens of thousands of public school employees, including classroom educators and support personnel, have been sent reduction in force notices, and are not anticipating being rehired in the coming school year.
To the issue of added cost, due to the mandating Social Security, the impact would be devastating to 95 percent of Texas school districts. These school employers and employees already make a contribution equal to 6.4 percent of their salary to the Texas teacher retirement system. The state legislature is bound by the Texas constitution to make a contribution, a minimum of six percent of the aggregate active teacher payroll.
I think it is speculative, at best, to assume that any of these contributions to the teacher retirement system in Texas will remain in the event that Congress mandates Social Security coverage for all public employees.
School districts and employees would be hard‑pressed to make an additional contribution to the Social Security trust fund, as well as maintaining contributions to the TRS pension fund. Our Texas TRS fund is presently valued at around $110 billion. It is about 82.3 percent funded. Redirecting contributions away from this fund to cover a new federal mandate for Social Security coverage would quickly destabilize the fund, and jeopardize the long‑term financial security of 1.3 million Texans. To break that number down even further, 1 out of every 20 Texans depends on the TRS Texas as their primary source of their retirement or future retirement security.
Texas has taken bold steps to maintain the health of the public retirement system, and projections suggest that TRS Texas is able to meet current and future obligations through the year 2114. Mandating Social Security coverage would have a profound negative impact on that funding status, and leads us in the wrong direction, and jeopardizes the long‑term funding of the retirement system.
Some suggest that current retirees may be held harmless by mandating Social Security coverage for only newly hired active employees, contending this would make it less onerous for public employers. But nothing could be further from the truth. Public sector‑defined benefit plans rely on constant reliable revenue stream in order to meet actual real goals and provide a retirement benefit for plan participants at affordable contribution levels. Proponents of this solution fail to understand that the normal cost of the existing retirement plan will increase as percentage of payroll as younger members are eliminated from the plan.
Thus, employers and new workers will not only have to add additional 6.2 percent of the new payroll tax, but employers may also have to increase contributions to the existing plan, or cut benefits. When states and localities are under extreme fiscal stress, as they are currently, this added expense will create enormous burdens with negligible, if any, positive outcomes.
Those positive outcomes are significantly less positive than one may realize. A study by the General Accountability Office concluded that a new hire would only add two years, at most, to the Social Security solvency. The same report stated that moving to mandatory coverage would be very costly to the states involved. As a result, mandatory coverage provides no long‑term solution to the Social Security issue, but it creates a huge, unfunded mandate on state and local governments. Destabilizing state designed, state‑funded public pension plans would have grave repercussions across a public and private spectrum alike.
Considering this, the ‑‑ consider this. The teacher retirement system pension fund pays about 6.6 billion annually in benefits to over 300,000 current TRS Texas retirees. These benefit payments have a substantial impact on the Texas economy, including $640 million in state taxes paid, 260 million in local government revenues, and helps create more than 91,500 permanent jobs in Texas.
And I will skip to the end, Mr. Chairman. Mandating Social Security coverage for all public sector workers would only create an enormous unfunded federal mandate on state and local taxpayers, and major costs and burdens for public employers, without contributing significantly to the solvency of the Social Security program. Millions of public employees have placed their faith and their future in the pension plans, and have planned for their retirement accordingly. It is absolutely critical to maintain the stability and confidence, the security of those public pension plans for their employees. And we will work to continue to do so.
Thank you for the opportunity to testify, and thank you for your staff’s work in helping me be here today.
I appreciate it.
[The statement of Mr. Lee follows:]
*Chairman Johnson. Thank you, sir.
*Mr. Lee. Thank you.
*Chairman Johnson. Thank you for being here. And you know, I don’t think there are very many of us that want to impose a tax on any state. And, as you know, the state of Texas, along with a lot of others, some of their associations, fireman and police, opted out of Social Security for a private retirement fund. And that is what America is all about, in my view.
Alex Brill, a research fellow, American Enterprise Institute, you are recognized for five minutes.
STATEMENT OF ALEX BRILL, RESEARCH FELLOW, AMERICAN ENTERPRISE INSTITUTE
*Mr. Brill. Thank you very much, Chairman Johnson, Ranking Member Becerra, other members of the subcommittee, for the opportunity to appear before you this afternoon to testify on this important topic.
To establish Social Security as a sustainable, solvent program, changes are certainly necessary. Absent structural reforms, scheduled benefits will exceed income by roughly 30 percent in 25 years. From a mechanical accounting perspective, a sustainable Social Security program could be achieved by either a reduction in the rate of growth of future benefits, or through tax increases. But these two options have different economic effects, particularly the effect on labor supply. Advocates of reform proposals that offer a combination of both revenue increases and benefit reductions sometimes argue that a solution involving both sides of the ledger is a “balanced approach.” However, once one considers the economic impact of different changes, that balance may shift considerably.
This hearing is about the revenue matters with regard to Social Security. And so, in my testimony I will focus briefly on the economic consequences of tax changes.
First and foremost, I would like to stress that in evaluating any tax increase geared at addressing the solvency of the Social Security system, the burden of the tax is greater than just the tax itself. Taxpayers alter their behavior in response to tax changes. And this behavioral response is not without consequence. It gives rise to what economists call an excess burden. The greater the taxpayers’ response to avoid the tax, the greater the excess burden. This behavioral response, that may result from an increase in the payroll tax rate, includes fewer hours worked and a shift from taxable wage income to non‑taxed fringe benefits.
Described earlier, the payroll tax is a tax on wages, not total worker compensation. And, therefore, it generally creates a distortion between wage compensation and non‑wage compensation, such as health benefits and many other non‑taxed fringe benefits. When an employer pays a worker wages, the employer deducts that cost from his own taxes, while the worker reports the wages as taxable income. However, when an employer compensates a worker with a non‑taxable fringe benefit, it too, is deducted from the employer’s income, but excluded from the worker’s income.
As a result of this distortion, there has been a decrease of wages as a share of total employee compensation. Today, approximately one out of every five dollars of compensation is non‑wage, almost all of which is excluded from taxable income ‑‑ income tax and payroll taxes. The shift from wage to non‑taxed fringe benefits has eroded the payroll tax base over time. And while many Social Security reform proposals subject a greater share of payroll to the payroll tax, few have focused on more broadly taxing compensation income.
For some workers, higher payroll taxes affect decisions about whether or how much to work. With regard to the impact of higher payroll taxes on labor supply, it is important to also note that the behavioral responses vary considerably across workers of different types. For example, a number of economists have documented that married female workers are more likely to reduce their labor supply as a result of a marginal tax increase. It has also been documented that high marginal tax rates also discourage entrepreneurship, and reduce the business activity of sole proprietorships.
Tax rate increases will generate more income for the Social Security trust funds, but that additional revenue comes at a cost. Higher marginal rates will discourage labor supply and, through other means of shifting, reduce taxable income. In addition to less economic output, such a change will lead to a significant decline in both federal and state income taxes.
The least bad of the various tax options would be a broadening of the tax base by taxing fringe benefits. This would at least eliminate some of the existing distortions between wage and non‑wage compensation. Such a change, if combined with a reduction in the statutory payroll tax rate, could reduce the excess burden of the payroll tax.
However, there are many other reforms worth adopting before considering tax increases. While those issues are beyond the scope of this hearing, I would encourage the committee to explore changes to the retirement age, the benefit formula, and the consumer price index methodology for calculating cost of living adjustments before considering tax increases.
I will conclude by reiterating that raising tax rates to prevent insolvency is likely to discourage work, and thus, long‑term economic growth.
I would also like to express to the committee my view that Congress need not wait until a full reform that actuaries estimate will return the trust funds to long‑run solvency can be agreed to. Many incremental reforms can and should be considered now. The sooner Congress adopts pro‑solvency measures, the less consequential they need to be. Thank you, and I look forward to answering your questions.
[The statement of Mr. Brill follows:]
*Chairman Johnson. Thank you, sir. I appreciate your remarks.
Dr. Warshawsky, a former assistant secretary for economic policy, U.S. Department of the Treasury, you are recognized, sir.
STATEMENT OF MARK J. WARSHAWSKY, PH.D., FORMER ASSISTANT SECRETARY FOR ECONOMIC POLICY, U.S. DEPARTMENT OF THE TREASURY
*Mr. Warshawsky. Thank you very much, Chairman Johnson, Ranking Member Becerra, and members of the Subcommittee on Social Security. I appreciate the opportunity to be here. I would like to congratulate you for holding this hearing discussing the revenue options for Social Security reform.
As the recent Social Security trustees report shows, the program’s financial status has worsened both in the short and long term. Social Security is now running large and soon to be rapidly growing cash flow deficits, adding to the federal debt outstanding held by the public and the budget deficits of the Federal Government. The day is steadily growing closer when benefits by law will have to be cut. Indeed, for disabled beneficiaries and their families, this is projected to occur in seven years.
It is good that we are now discussing more actively options to strengthen Social Security, and it is promising that many groups and individuals and legislators have put forward specific proposals. At the same time, not all provisions and all reform plans are good policy.
For example, there are proposals coming from the deficit reduction commissions and elsewhere to increase Social Security payroll taxes substantially by increasing the contribution and benefit base. In particular, the commissions propose to increase the Social Security contribution and benefit base ‑‑ also called the taxable maximum ‑‑ by an additional two percent each year, starting in 2012, until 90 percent of total earnings of the labor force are taxed.
If the increase were to happen in one step in 2012, the taxable maximum would be about $215,000, up from $106,800 today. This is a very large tax increase on about 10 million of our most productive workers. Almost 99 percent of workers would then be subject to Social Security taxation on all of their earnings, up from about 94.5 percent today.
This proposed provision is a bad idea for at least four reasons, in addition to the general ill effects of tax increases.
It unfairly targets a specific segment of the population that has not seen particularly large gains in earnings. It is an extra burden, in addition to the new taxes imposed on this and other groups to finance Medicare and in the recent health care legislation. It will cut pre‑retirement savings. And it represents an unnecessary expansion of Social Security. Let me explain briefly each.
Those who advocate an increase in the taxable maximum have indicated that their goal is to have 90 percent of total earnings in the labor force subject to Social Security taxation. This taxable coverage ratio has fluctuated over the history of the program, from as little as 71 percent in 1965 to a high of 90 percent in 1983. And most recently, in 2009, it was 85.7 percent. The use of this ratio for policy design seems very arbitrary. But I think what the advocates are getting at is a deeper concern about the distribution of income and earnings, more broadly. And they claim, based on some research, that there has been an increase in inequality.
But then consider another study that focuses on the wages of private sector workers, ages 25 to 60, over a long period of time. It finds that the increase in equality has slowed since the late 1980s, and that the vast majority of the increase for the top 20 percent of workers, the first group since 1980 is due to those above the 1 percent, the top percentile, the second group that is, those earning more than $215,000. And this is confirmed also looking at estimates from Social Security wage data.
So, the first group, which is the larger group, has had wage increases much more modest than the upper group. Punishing the first group with a much bigger tax increase than the second group would be very unfair.
The second reason why an increase in the taxable maximum is a bad policy is that workers in this segment ‑‑ and also those with higher earnings, in the upper earnings distribution ‑‑ are already bearing significant increases in payroll taxes, and are scheduled for further increases soon.
In 1991 the earnings cap for Medicare health insurance was increased, and in 1994 it was lifted entirely. So these workers already have seen a significant payroll tax increase of 2.9 percent of earnings. Under the new health care law, an additional payroll tax, HI payroll tax of .9 percent will be levied from workers earning above $200,000 for singles, $250,000 for joint filers. Because these thresholds are not indexed, many of the same workers would be hit by this tax increase as the increase that was proposed by lifting the Social Security taxable maximum.
The third reason for opposition to this increase is that it will reduce private retirement savings. We have done work using a comprehensive retirement planning model for some illustrative household situations, and a colleague and I have found that those individuals earning above $106,000 that would be hit by this tax increase would reduce their retirement savings by about 4 percent.
When you translate that across 10 million workers, that is a significantly lower amount of domestic sources of investment capital.
Finally, an increase in the wage contribution of benefit base is an unnecessary expansion of the program. An increase is unnecessary, because there are fairer and better ways to bring Social Security to permanent solvency with no payroll tax increase, which would involve changes in several aspects of the program affecting different groups that, together, add up to sustainability. Thank you.
[The statement of Mr. Warshawsky follows:]
*Chairman Johnson. Thank you, sir. I agree with your last statement, wholeheartedly.
Andrew Biggs, doctor ‑‑ is it Andy?
*Mr. Biggs. It is.
*Chairman Johnson. Yes, that’s what I thought. Resident scholar, American Enterprise Institute, you are recognized for five minutes.
STATEMENT OF ANDREW G. BIGGS, RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE
*Mr. Biggs. Thank you very much. Mr. Chairman, Ranking Member Becerra, members of the subcommittee. Thank you for offering me the opportunity to testify today with regard to Social Security’s finances.
The American population is aging, which means that smaller numbers of workers must support larger populations of retirees. To help them do so, public policy should encourage individuals to do three things: work more, meaning more hours of the week and more weeks of the year; save more, meaning greater contributions to retirement plans and other savings vehicles; and retire later, meaning delaying retirement past 62, the most common age of claiming Social Security benefits.
If we improve the incentives for Americans with regard to work, saving, and retirement ages, we can boost the economy and increase our capacity to finance rising entitlement costs. How would fixing Social Security through tax increases affect these efforts?
Put broadly, increased taxes generally mean that individuals will work less, because the reward for working has been reduced; save less, because they have less after‑tax income with which to save, and less reason to save, as entitlement programs would be more generous; and retire earlier, because Social Security benefits would appear more generous, relative to their after‑tax pre‑retirement earnings. In other words, higher taxes work opposite to economic‑level goals that most analysts would accept.
We may disagree regarding how large the effects of raising taxes would be. We might also conclude that some policy goals are so important that the negative economic effects of tax increases are a price worth paying. But we should not dispute that raising taxes imposes a cost on the economy’s ability to support growing populations of retirees.
The most common proposal for raising Social Security taxes is lifting or eliminating the maximum taxable wage. With regard to raising the so‑called tax max, I would make four points.
First, the current payroll tax ceiling is not unusually low, by historical standards. As of 2009, 85 percent of total wages were subject to the payroll tax. From 1937 through 2009, the average was 84 percent. And from 1950 through 1970, only 78 percent of total earnings were subject to taxes.
Second, Social Security’s payroll tax ceiling also is not unusually low, relative to other developed countries. Across 22 OECD countries, pension taxes were, on average, applied up to 2.1 times the average wage. In the U.S., the Social Security payroll tax is applied up to around 2.9 times the average wage, a significantly higher tax cap than in the UK, Germany, Canada, or other competing countries.
Third, eliminating the payroll tax ceiling could lead to very high marginal tax rates. Based on the tax rates proposed by the administration, eliminating the tax max would raise the top all‑in marginal tax rate to an average of 63 percent, and higher than that in some states. And these taxes would be before we had done much of anything to fix Medicare and Medicaid.
Fourth, roughly one‑quarter of the revenue gains from eliminating the tax max would be offset by lower tax receipts in other areas. This result does not depend on assuming that individuals change their work behavior. Rather, employers would reduce workers’ wages to compensate for their own higher payroll tax liabilities. These reduced worker wages would lower receipts from federal income taxes, Medicare payroll taxes, and state income taxes.
If individuals made even modest behavioral responses to higher taxes, then about half the gross revenues from eliminating the payroll tax ceiling would be lost, according to a study by Professors Jeffrey Liebman of Harvard University, and Emmanuel Saez of the University of California, Berkeley.
Lawmakers face a choice: policies that encourage work and saving, or retaining the safety net for the poor, versus policies that discourage work and saving. Our ability to care for those in need springs from the goods and services produced in the economy. If we penalize workers who produce those goods and services, the goals of Social Security and other federal programs will be more difficult to achieve. Thank you very much.
[The statement of Mr. Biggs follows:]
*Chairman Johnson. Thank you, sir. I appreciate all of your testimony. I don’t think any of us up here ‑‑ on this side, anyway ‑‑ want to raise taxes. But we will have to see what falls out.
Mr. Goss, in 2010 the maximum amount of earnings subject to the 12.4 percent payroll tax was 106,800, same as this year. And 84.2 percent of covered earnings were subject to the tax. What would the maximum amount be this year if 90 percent of covered earnings were subject to the payroll tax?
*Mr. Goss. Dr. Warshawsky addressed that point already, and it would be somewhat in excess of 200,000. We estimate that by the time we get to 2020, if we were to go to a 90 percent taxable instead of the roughly 82.5 percent taxable that we expect to have at that time, it would be a little bit over double the taxable maximum amoumt that we would have, otherwise.
*Chairman Johnson. Yes. Are you in favor of that?
*Mr. Goss. We are in favor of solvency and strengthening Social Security ‑‑
*Chairman Johnson. Okay.
*Mr. Goss. ‑‑ absolutely, by whatever means you all determine.
*Chairman Johnson. Okay, 202,500 is what it would be today.
Dr. Biggs and Mr. Brill, the Congressional Budget Office produced a policy option publication for Congress last July. In it they stated, “Like all taxes on earnings, Social Security taxes reduce the award from work, which tends to decrease how much people work.”
The Joint Committee on Taxation recently completed a revenue analysis for me, and the analysis says that 2.8 trillion in self‑employment income, and 13.4 trillion in wage income, would be subject to payroll taxes over the next decade if the wage base were eliminated. If the taxable wage base were lifted to cover 90 percent of earnings, those numbers would be 500 billion and 4.4 trillion, respectively.
Given these facts from CBO and Joint Tax, do you think that raising the wage base would keep this country from creating new jobs in this country that we desperately need? Either one of you.
*Mr. Biggs. Well, as I noted in my testimony, I believe that we need to concentrate on economy‑level goals of work, saving, investment, the things that will strengthen the economy and allow us to support larger populations of retirees.
With regard to the effects of taxation, I think I would raise three points. One is that the negative economic effects of a tax increase depend, first, on the size of the tax increase. A 12.4 percent increase in the marginal tax rate is large, by itself.
Second, it depends on the tax it’s already stacked on top of. If people are already paying high marginal tax rates, and then you add more to it, the economic effects are more significant than if you were stacking that tax increase on a low tax rate.
Third, higher‑income individuals tend to be the most sensitive to marginal tax rates. So, essentially, you are applying this tax increase in the place where you are going to have the most negative economic effects from it. So I think it is just not, in my mind, a particularly productive way of going about this problem.
*Chairman Johnson. Do you agree with that?
*Mr. Brill. I do agree. I agree with Mr. Biggs’s points. And I would just add that the response that we could anticipate ‑‑ your question focused on labor and job creation ‑‑ a number of the small business and medium businesses are pass‑through entities, taxed through the ordinary individual income tax, not the corporate tax system. Roughly half of small business income is taxed by individuals at relatively high income rates. Raising the cap, whether it be to 90 percent ‑‑ in other words, to $200,000 ‑‑ or taking the cap off all together, would raise the marginal rates significantly on those small businesses.
*Chairman Johnson. Yes, and small businesses ‑‑ our studies indicate that is where most of the jobs are created. Is that true?
*Chairman Johnson. Dr. Biggs and Mr. Brill, from an economic viewpoint, how do you think small business owners would react if Congress raised their marginal payroll tax 12.4 percent? What would be the business response, particularly during these times?
*Mr. Brill. Research by Doug Holtz‑Eakin and Bob Carroll and others have noted that the response from sole proprietorships to increases in tax rates can be significant. So a reduced amount of business activity from these small employers. It could be on the order of magnitude to a five to seven percent reduction in activity.
In addition, there is a shift in the amount of taxable income that is reported, different than a shift in the economic activity. But both of these are important consequences. So there is both an effect to federal revenues on the income tax side, as well as a real effect on the economy.
*Chairman Johnson. Thank you.
*Mr. Biggs. I believe the effects would be larger on the small business end than they would be for individuals working for other employers. Small businesses have more capacity to shift the way compensation is paid out, where individual employees have less. So I think the negative effects we are talking about would be larger on the small business end than they would be in the rest of the workforce.
*Chairman Johnson. Yes, it is negative overall, in my view, too.
Mr. Becerra, you are recognized for five minutes.
*Mr. Becerra. Thank you, Mr. Chairman, and thank you all for your testimony and for having taken the time to shed some light on the issues of Social Security.
Interesting, Mr. Brill, I take a couple of things from your testimony that I think are very important that we have to really consider. Non‑wage compensation does not get taxed, for payroll purposes, to provide the funds for Social Security.
So we find ourselves in a situation where, if you are a worker in America who relies principally on your paycheck, and your income is anywhere between, you know, 0 to $106,800, you are subject to the full level of the Social Security payroll tax contribution to the system. But if you rely on a paycheck for part of your income, but the lion’s share of your income comes from other non‑payroll sources ‑‑ and obviously, an extreme example would be a Bill Gates or perhaps a Wall Street executive, there is a good chance that the vast majority of their income doesn’t get taxed for payroll purposes.
So there are a whole bunch of Americans who are making vast sums of income who, because they don’t get it through a paycheck, don’t have to contribute to the Social Security system beyond whatever they get as a paycheck for a directly‑compensated wage. That is an excellent area of examination. Because I think you talked about how you have to figure out how you broaden the base in a fair way. And I think we should try to explore that a bit more.
Mr. Biggs, you pointed out something that I think most Americans don’t often think about, and may have to swallow kind of hard to recognize or accept, and that is ‑‑ you said you have to work more, save more, and retire later. I think in America, the goal of most Americans is to be able to retire earlier ‑‑ save more, and retire earlier, rather than have to work more, have to save more, and retire later.
And I think the way you tried to explain it, though, it makes it clear you are not telling folks, “Hey, this is a new day in America, where we are going to work longer and get less,” what we are simply saying is, “Be smart about the way you save, understand what it means to have to work hard, and be prepared to know what it will take for you to live out the rest of your years, if you are going to retire, whether you retire early or not.”
And I think, too often, Americans don’t really plan for what it will take to live out their retirement in dignity. And then that is where I think Social Security has become a tremendous asset in this recent heavy recession, and I think makes it very clear why so many seniors have become so protective of Social Security benefits.
I want to ask a quick question. Are any of you familiar with Mr. Sessions’s ‑‑ Pete Sessions ‑‑ legislation that he recently introduced, H.R. 2109?
*Mr. Becerra. I referenced it in my opening remarks. It is legislation which essentially privatizes Social Security, because it allows workers today to not contribute into the system, and instead, create their own private accounts.
And unlike previous privatization proposals, in this case, in the Sessions legislation, there would be no backfilling of the lost revenues by having today’s workers no longer put money into the system, and instead, only put money into a private account. Most of the previous privatization proposals at least recognized that Americans who are retired today because they were working and contributing to the system yesterday should not be expected to take the massive loss of benefits, as a result of having today’s workers no longer contributing to the system.
Mr. Goss, I have tried to explain an aspect of the Sessions legislation. Obviously, it goes well beyond that into other areas, as well. But what would happen if you had a system where you created a system ‑‑ I would no longer call it Social Security, because it would become a privatized system, where no longer would American workers contribute, starting today, into the Social Security system and the trust fund? What would happen to today’s retirees?
*Mr. Goss. Very good question. We have not been asked to do a formal estimate of the plan, but we are familiar with it. My understanding of the plan is that workers today who are not yet retired and not receiving benefits would have the option to start paying one half of the taxes, and after 15 years not to pay any of the taxes themselves, and by their employers.
People who are over 40 ‑‑ especially over 50 ‑‑ probably wouldn’t want to do this, because they have a substantial investment in Social Security already. For people who are under 40, they may well decide that the amount of money that they could put into an account would be sufficient that they would be willing to walk away from the Social Security benefits that have been scheduled for them.
What this would mean, though, to the extent that people did this, is that the amount of revenue coming into Social Security would be dramatically reduced. Already, as many on the panel have pointed out, we do not have enough taxes coming in over the future to be able to pay for scheduled benefits, as it is. Taxes would be reduced ‑‑ essentially, immediately ‑‑ by a substantial degree, and we would not have any offsetting reduction in benefits until people who are under 40 now got to the point of receiving benefits.
So, for Social Security ‑‑ the ability to pay benefits to people who are currently receiving or are now approaching the time of receipt of benefits would be severely compromised. Trust fund exhaustion would certainly come much sooner than 2036. And the extent to which we have cash flow shortfalls, and the speed with which we would be spending down our trust fund assets, would be much, much faster.
*Mr. Becerra. Thank you. Thank you, Mr. Chairman.
*Chairman Johnson. Thank you. Mr. Smith, you are recognized.
*Mr. Smith. Thank you, Mr. Chairman. And thank you to our witnesses, for sharing your expertise and your time.
We have heard various characterizations of Social Security, that everything is just fine and so forth. And I am trying to grapple with various points of information and perspectives.
But Mr. Goss, would you describe Social Security as actuarially sound?
*Mr. Goss. Thank you very much for the question. Clearly, we do not project that Social Security is solvent over the next 75 years. We will reach the point in 2036, if nothing is done ‑‑ and we trust something will be done ‑‑ that the trust funds will become exhausted and won’t be able to pay full benefits. As Chairman Johnson indicated, at that point in time, 77 percent of scheduled benefits would be payable.
So, changes clearly need to be made. We need to either increase revenue or, to reduce the scheduled benefits to match the revenue already being put on the table under current law.
*Mr. Smith. But is there even a mechanism to reduce those benefits, should nothing be done?
*Mr. Goss. Well, actually, there is. Social Security OASI, DI, and the Medicare Hospital Insurance funds are special in the Federal Government. Most programs in the Federal Government, as we know too well, can run deficits for a long time, and actually build up a lot of debt. We have over $14 trillion of total federal debt now. Social Security does not have any debt. In fact, it cannot have debt, by statute. It is not allowed to have debt.
From the point of its inception, it has to always have taken in more money than it has paid out. So there is a natural breaking force spending, there is a scrutiny that is applied to the trust fund programs. If we reach the point where the trust funds run out, and there is no action by Congress, we will have no choice but to pay out only then what the trust funds have available, which will be $.77 on a dollar.
That would be ‑‑ I don’t know if catastrophic is too strong a word, but that would be a terrible situation. You cannot ‑‑ anybody would not want to have our beneficiaries, from one day to the next, drop by 23 percent in the amount that they receive. So we have absolute confidence that the Congress will act between now and that time, and hopefully sooner.
*Mr. Smith. Okay, thank you. Dr. Biggs, in your testimony you note that while only six percent of workers reach the taxable maximum in a given year, almost a quarter of workers would be affected by such an increase over their lifetimes. Could you expand on this?
*Mr. Biggs. Sure. In an given year, around six percent of employees have earnings above the taxable maximum of around $107,000. We had periods in the past ‑‑ I think from 1950 to 1970 that actually were around 20 or 22 percent of workers were above that tax cap in any given year.
Today it is only six percent, but it is not the same six percent year after year. Some people have good years, some people have bad years. If you look at the course of individuals’ full working lifetimes, somewhere ‑‑ my number is around 24 percent ‑‑ would have had some earnings above that cap at some point in their career. And so, if you lift or eliminate the cap, would have been subject to that higher tax rate.
*Mr. Smith. Mr. Brill, certainly the six percent sounds like a small number. But if these are entrepreneurs and job creators, how does that impact our economy and our effort to reverse this recession?
*Mr. Brill. I think, actually, the more important number is the larger number that you referenced, the 24 or 25 percent, because what is important to keep in mind is it is not only those taxpayers who are facing the higher tax rate currently, but those that would risk facing it if they were successful.
So, research on the economic consequences of entrepreneurship have confirmed this, that if an individual who is making $100,000 is considering a new venture, a risky venture that, if things work out well, his income or her income would jump to $200,000, knowing that their tax rate would increase substantially at the same time may discourage some of that activity.
So, it is important to focus not just on those who are actually affected at the moment, but those who are at risk of facing the higher tax, as well.
*Mr. Smith. Okay. Dr. Warshawsky, would you care to comment?
*Mr. Warshawsky. I agree with the statistics that have been put forward. But I think it is also very helpful to give some characterization of who these workers are. The typical earnings profile of many workers is that they reach their peak in their early fifties, when they have their highest earnings potential. This is after years of education, hard work, supporting growing children. And these people have been hit pretty hard by high education costs, high health care costs.
So, I think it is important to sort of get a sense of the character of these workers.
*Mr. Smith. Okay. Thank you. Thank you, Mr. Chairman. I yield back.
*Chairman Johnson. Thank you, Mr. Smith. Mr. Berg, you are recognized.
*Mr. Berg. Well, thank you, Mr. Chairman. I wanted to explore a little bit the question that comes up always that there is income that people receive that they are not paying, you know, FICA or SECA on. What is an example of what people use for that? There is some specific revenue that you hear a lot? Please.
*Mr. Goss. We have on page nine of the written testimony identified a couple proposals that could generate revenue that have been put forth by the bipartisan policy center workgroup, and one of them actually by Paul Ryan, in his roadmap plan, that would not increase the taxable maximum amount. These are plans, instead, that would look at employee compensation that is now not taxed, but would become taxed.
One of these items that would cover about 42 percent of our 75‑year shortfall would be to tax the employer‑sponsored group health insurance premiums, whether those are paid for by employees or by employers. Currently, they are generally not subject to the FICA tax. If those were subject to the FICA tax over a gradual period of time, phased in as this particular proposal would suggest, we could cover almost half of the 75‑year shortfall.
Another smaller approach toward covering a portion of this would be to cover certain section 125 cafeteria plans by which employees can pay for a portion of some fringe benefits that they receive. These are also tax exempt currently. Most of this, as we have learned from our friends at Joint Committee on Taxation, is the employee share of employer‑sponsored group health insurance. If we were to make that no longer FICA tax‑exempt, that would cover about 10 percent of the long‑term shortfall for Social Security.
So, there are options, other than just raising taxes.
*Mr. Berg. And I was just curious, because I hear people talking about that, and now I know that what they are talking about is simply taxing health care benefits, or employer‑provided health care benefits.
The other question I had ‑‑ and again, we had a reduction in 2010 where we went from 6.2 to 4.2, and I guess I was just wondering if any of the panelists here have ‑‑ do we have any results from that, that we can say, “Hey, that was a good decision,” or a poor decision, or ‑‑ what was the impact of that? Anyone wish to address that? Or is it too early to tell?
*Mr. Goss. Well, I would just ‑‑
*Mr. Berg. Do you get paid extra? Are you getting paid by the ‑‑ no.
*Mr. Goss. Okay.
*Mr. Berg. No, no.
*Mr. Goss. A portion of that legislation suggests that the trust funds, per se, would not be affected. The revenue coming into the trust funds has been maintained exactly as though the tax rate were not reduced.
So, effectively, one might suggest that it was a mechanism by which the amount that employees and self‑employed had to pay to the Federal Government was reduced by 2 percent of their pay, up to the $106,800. Trust funds are not affected, and the long‑term solvency is not affected.
*Mr. Berg. I can’t understand that. Why is the trust fund not affected, or the long‑term? Are we taking dollars and putting it in there to offset that two percent?
*Mr. Goss. We ‑‑
*Mr. Berg. Okay.
*Mr. Goss. The trust fund continued to be credited, not by money that was coming in in payroll taxes, but money from the general fund to the treasury.
*Mr. Berg. Right, right, okay.
*Mr. Goss. And this is a special ‑‑
*Mr. Berg. I follow you, I follow you.
*Mr. Goss. ‑‑ a special one‑year thing in 2011.
*Mr. Berg. So now, what is the benefit, then?
*Mr. Goss. Well, the benefit ‑‑ I think some of our economists could probably speak better ‑‑
*Mr. Berg. I see some smiles, though.
*Mr. Goss. ‑‑ to this than I.
*Mr. Berg. Whoever has the biggest smile starts.
*Mr. Warshawsky. I am anxious to hear what Steve will say.
*Mr. Goss. But we have heard much discussion about the impact on economic growth and desire to work by having taxes increase. This effectively was a one‑year decrease in taxes for employees and for self‑employed. The intent, presumably, was to encourage more work and more employment during that period. I am not sure that anybody can really measure what the impact is.
*Mr. Brill. I would just comment that if we are thinking about changing the tax rates as a tool to create jobs, we need to distinguish between temporary tax policies and permanent policies. This policy, which was a temporary one, while technically it may be too early to do the analysis, and it is always hard to know the but‑for case, but certainly the labor market is not improving while this policy is in place.
*Mr. Warshawsky. I would just comment again. I have not seen any studies in it. I would imagine it is premature. But I think the American public sees that Social Security has financial troubles, and that the Federal Government has financial troubles, and with this sort of temporary tax cut, people, you know, are uncertain. They don’t know. Does that mean taxes will increase in the future?
*Mr. Berg. I just ‑‑ let me ‑‑ it is clear to me. I, of course, just come from little old North Dakota. And it seems that out here everything is pretty temporary, and a cloud of uncertainty over business and over everything. A cloud of uncertainty is over Social Security. People need to know what is going to happen.
And again, just to add to that, I think we need long‑term solutions for solvency, whether it is our country’s cash flow, whether it is our country’s regulatory environment, whether it is our country’s tax environment, simply having a path that people can look down the road and have confidence that it is going to be there is really what is critical.
So, just one final question. What is the cost? Does anyone know what the cost of the two percent is, then, to the general fund? Do we have a number on what that is?
*Mr. Goss. So for 2010 and some of the cost for 2011 slipping into 2012, it is about $110 billion in total.
*Mr. Berg. And that is set to expire in December of 2011, or ‑‑
*Mr. Goss. Or the beginning of 2012. Work in 2012 will no longer be subject to the 2 percent reduction.
*Mr. Berg. Okay.
*Mr. Goss. In payroll tax.
*Mr. Berg. Thank you. I yield back.
*Chairman Johnson. Thank you, Mr. Berg. Mr. Marchant, you are recognized.
*Mr. Marchant. Thank you, Mr. Johnson. Mr. Brill, the President is proposing that we cut the employer’s payroll taxes to create jobs. Other Members of Congress ‑‑ the Democratic Members of Congress ‑‑ are proposing that we raise payroll taxes in order to make the Social Security fund solvent.
Which of those two policies would create more jobs, or make the fund become more solvent? Which one of those policies should we select?
*Mr. Brill. Are there any other choices?
*Mr. Marchant. I won’t select either one of those, but those are the proposals ‑‑
*Mr. Brill. I would just note again, as I remarked to Congressman Berg, the important distinction between those two, in addition to the fact that one is going up and the other one is going down, is that one is temporary and the other one is permanent. The evidence of temporary tax policies on permanent job creation is shaky, at best.
And as we were just noting, a recent experience may be too soon to analyze, but it seems unlikely that we would get a large benefit from a temporary payroll tax, whether it be on the employee side or the employer side. Of course, there have been a number of attempts at temporary policies in the last few years, none of which seem to have been particularly effective.
On the other side, raising the cap is a permanent policy, and employers and employees experiencing long‑term, higher marginal rates are less likely to engage in work.
*Mr. Marchant. As someone that is a small employer, as well as a Member of Congress, and my brother as well, we have had this discussion in the last week about what happens in January, when all of a sudden the two percent goes away, and all of a sudden the same exact check to one of our ‑‑ the foreman in this case, $68, will ‑‑ the foreman will be paid exactly the same amount, but there will be $68 less in his paycheck.
Is there any of you on the panel that have any opinion about how ‑‑ what effect that is going to have on employment, if Congress or the administration is not able to extend that deduction? Dr. Biggs, how about you?
*Mr. Biggs. I think I would agree with some of the others, that I suspect the effects on employment of temporary payroll tax cuts will be small. And so, if we didn’t see a lot of job gains through the payroll tax cut ‑‑ and I suspect we didn’t ‑‑ then probably we won’t see a lot of job losses when the payroll tax goes back to its original level. That is my gut on this.
It may be possible to do some research in further years and figure it out, but if you are looking to hire somebody, particularly if you are looking to hire somebody for a quality job, you know, what we call a “good job,” it is somebody you want to have them stick around for a while, you know, a permanent employee, a two percent cut in your labor cost in one year is not really enough to say, you know, “I am going to go out and add a whole load of new people.” It is just ‑‑ the temporary nature of it just ‑‑ I don’t think will have that big an effect.
So, I tend to think the positive effects were small, and the negative effects, when it goes away, also will be small.
*Mr. Marchant. And, Mr. Chairman, if I could ask a question that I promised a gentleman last week ‑‑ when he found out that I was going to be on the Social Security Subcommittee, he asked me to ask this as a question.
What is ‑‑ and I will ask this to Mr. Goss ‑‑ what is the definition of a gap baby? Notch baby, I am sorry.
*Mr. Goss. Notch.
*Mr. Marchant. Because this gentleman obviously is a notch baby.
*Mr. Goss. Okay.
*Mr. Marchant. And he calls often.
*Mr. Goss. We apologize for that. There was a certain period of time during which births reached retirement age in a period when, as a result of the 1977 Social Security amendments, because the benefit levels were rising at, really, an unsustainable rate, these so‑called replacement ratios, benefits relative to wage levels, were growing out of control. And the 1977 Social Security amendments came along and corrected that.
But the Congress at that time decided that the benefits had risen to a level that was about six percent higher than they thought made sense. So they actually, over a period of five or six years worth of retirees, pulled the benefit levels down. As a result of having the benefit levels pulled down over that period, we ended up with a situation which really defines what a notch is: people retiring this year, say at 62, actually getting less when they retire at 62 than a person who is now 63, had the same job, and retired a year ago.
And so, if a person retiring now is getting less than a person who retired a year ago from the same job, then that is defined as a notch that is something which, when we design proposals ‑‑ everybody who is sitting behind you knows well ‑‑ this is something we strive to avoid, having notches in the future so you won’t have any more cards and letters.
*Mr. Marchant. Okay. Thank you, Mr. Chairman.
*Chairman Johnson. Try not to ask that question any more.
*Chairman Johnson. Let’s see, Mr. Tiberi.
*Mr. Tiberi. Thank you, Mr. Chairman. Thanks for having this hearing.
Mr. Goss, remind us up here. When Social Security was created, my understanding is that President Roosevelt stressed that this would not be a welfare system, that this would be a system that the benefits, the taxes that you paid, would equal the benefits that you incurred. And, therefore, if you were making $100,000, and paying tax on the $100,000, your benefit will be higher over a period of time if your average wage over time was $50,000, and thus you paid $50,000 into ‑‑ or taxes based on the $50,000. Is that correct? Is that how it works?
*Mr. Goss. That is absolutely correct. People who earn more, and therefore pay higher taxes, do get higher benefits. But it is not in direct proportion.
*Mr. Tiberi. Right.
*Mr. Goss. If you have somebody who makes $50,000 versus $100,000, the $100,000 will pay twice as much in the way of taxes. But because of the way the benefit formula has been put together, they will not get twice as much in the way of benefits.
*Mr. Tiberi. But they will get a percentage higher, because they put a percentage more in.
*Mr. Goss. They definitely will get more benefits.
*Mr. Tiberi. If we lift the cap ‑‑ the proposals to lift the cap haven’t corresponded to the theory that President Roosevelt has proposed, is that correct? My understanding is those who want to lift the cap want to also cap the benefit and then use the remainder to fund the system. Is that correct, or am I wrong?
*Mr. Goss. Well, we have a variety of proposals. One that has been discussed much here is to gradually raise the taxable maximum up, so that we will again be taxing 90 percent.
Actually, the fiscal commission and the bipartisan policy center commission came up with slightly different flavors of that. Generally speaking, if we do raise the taxable maximum, extra earnings that people have above the current taxable maximum might be confronted in our benefit formula with getting only a 15 percent return, as compared to about the average 48 percent return that earnings tend to get.
The fiscal commission actually suggested that the extra earnings should get not a 15, but a 5 percent return. So they were trying to achieve actually more solvency kick out of raising the taxable maximum than the bipartisan policy center is.
Other proposals have been put forth that would say that for the extra taxes paid in for higher earnings, there will be no extra benefit gains. So there is a great variety of possibilities that you might consider.
*Chairman Johnson. Dr. Biggs, would we lose public support, in your opinion, if we raise the tax? And we have heard from you and Mr. Brill about the negatives of raising the tax. But put that aside for now. Would we lose public support of the system, in your opinion, if we took the cap off and retirement benefits would be less than they are today for those earners, based upon the tax paid and the benefits received, whether it is 48 percent versus 15 or 48 percent versus 5 for the added amount?
*Mr. Biggs. Well, I think that that is an important issue, sort of a political economy issue, of how people view the program, and how that affects their support for it.
Historically, that issue is very, very important for President Roosevelt. He appointed a commission to develop sort of the skeleton of the Social Security program.
The interesting thing of what the committee on economic security came up with is they originally set this wage cap of $3,000, and they argue that anybody above that wage cap shouldn’t even participate in the program, that they should just go save on their own. So, under their structure, you wouldn’t have had any redistribution from these high earners to low earners. It was really seen as a universal insurance program, where everybody paid in, everybody got out.
The compromise they came to was a cap where you pay in taxes based up to $100,000 in earnings, and your benefits are based on those same taxes. So there was always this interchange between the two. If you made it too progressive, the argument was, it would be come to be seen was what Roosevelt called relief ‑‑ the phrase we use today is “welfare.”
Now, the question is how far can you push that. You can say we are going to eliminate the cap, and you are going to get an extra penny of earnings, or an extra penny of benefits. People say, “Okay, clearly, that is sort of a ‑‑ that makes kind of a joke of the situation.” So the question is, how far can you push it before you get the lack of political support, which, really, people have counted on for the program? If people don’t feel a program is fair, then the political support does tend to fall apart.
*Chairman Johnson. Thank you. Mr. Brill, you commented about the concern that, in raising Social Security revenue, there would be a detrimental impact on overall federal revenue. Can you expand upon that, why you believe that?
*Mr. Brill. Sure. I think this is an important consequence to appreciate when looking at raising the cap or raising the payroll tax rate. It depends, in part, on exactly the sensitivity of the workers, to what degree they respond to this higher tax rate. And there is a debate among academics to that response.
But there is absolutely shifting that will occur, and it would be reflected in any analysis that Tom and his team would undertake, or any work done by the CBO on this issue.
One paper that many have noted on this area is a working paper by Jeffrey Liebman and Emmanuel Saez. In that paper, they estimate the impact on a per‑worker basis of raising the payroll cap. In one example, a more conservative example, raising the cap to 90 percent from where it is now would result in $155 more in payroll taxes, but $67 less in other taxes being paid, as the workers shift their behavior and either work less or report less taxable wages. And so, in that sense, there is a decreasing amount of general fund revenues in exchange for increasing amounts of Social Security revenues.
*Chairman Johnson. Thank you. You know, you guys didn’t talk about raising the age limit at all. I am surprised.
And, Mr. Lee, you didn’t push your teachers out there, I am sorry to hear. Tell them hi when you get back, will you?
*Mr. Lee. I will, thank you.
*Chairman Johnson. I thank you all for being here today. This subcommittee will continue to monitor progress to make sure that Social Security is done right, within its means.
With that, the committee stands adjourned. Thank you all for being here.
[Whereupon, at 3:28 p.m., the subcommittee was adjourned.]
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