[Joint House and Senate Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 112-484
HOW THE TAXATION OF LABOR AND TRANSFER PAYMENTS AFFECT GROWTH AND
EMPLOYMENT
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
MAY 16, 2012
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Robert P. Casey, Jr., Pennsylvania, Kevin Brady, Texas, Vice Chairman
Chairman Michael C. Burgess, M.D., Texas
Jeff Bingaman, New Mexico John Campbell, California
Amy Klobuchar, Minnesota Sean P. Duffy, Wisconsin
Jim Webb, Virginia Justin Amash, Michigan
Mark R. Warner, Virginia Mick Mulvaney, South Carolina
Bernard Sanders, Vermont Maurice D. Hinchey, New York
Jim DeMint, South Carolina Carolyn B. Maloney, New York
Daniel Coats, Indiana Loretta Sanchez, California
Mike Lee, Utah Elijah E. Cummings, Maryland
Pat Toomey, Pennsylvania
William E. Hansen, Executive Director
Robert P. O'Quinn, Republican Staff Director
C O N T E N T S
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Opening Statements of Members
Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas 1
Witnesses
Dr. Richard Rogerson, Professor of Economics and Public Affairs,
Princeton University, Princeton, NJ............................ 3
Dr. Andrew G. Biggs, Resident Scholar, American Enterprise
Institute, Washington, DC...................................... 5
Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship,
Sloan School of Management, Massachusetts Institute of
Technology, Cambridge, MA...................................... 6
Submissions for the Record
Prepared statement of Vice Chairman Kevin Brady.................. 30
Chart titled ``A Tale of Two Recoveries'' submitted by
Representative Brady........................................... 31
Prepared statement of Dr. Richard Rogerson....................... 32
Prepared statement of Dr. Andrew G. Biggs........................ 44
Prepared statement of Dr. Simon Johnson.......................... 47
HOW THE TAXATION OF LABOR AND TRANSFER PAYMENTS AFFECT GROWTH AND
EMPLOYMENT
----------
WEDNESDAY, MAY 16, 2012
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The committee met, pursuant to call, at 2:15 p.m. in Room
G-50 of the Dirksen Senate Office Building, the Honorable Kevin
Brady, Vice Chairman, presiding.
Senators present: Bingaman.
Representatives present: Brady, Burgess, Duffy, and
Mulvaney.
Staff present: Conor Carroll, Gail Cohen, Colleen Healy,
Patrick Miller, Matt Salomon, Robert O'Quinn, and Steve
Robinson.
OPENING STATEMENT OF HON. KEVIN BRADY, VICE CHAIRMAN, A U.S.
REPRESENTATIVE FROM TEXAS
Vice Chairman Brady. Good morning, everyone.
I want to welcome you to the hearing on ``How the Taxation
of Labor and Transfer Payments Affect Growth and Employment.''
Today the Joint Economic Committee is holding the second of
two hearings on how taxes affect America's economy. This
hearing is on the taxation of labor. The first hearing was
focused on the taxation of capital.
My goal, as Vice Chairman of the Joint Economic Committee,
is to ensure that America has the strongest economy in the
world throughout the 21st Century. To do that, we have to get
our monetary policy right, our fiscal policy right, our
regulatory policies right, and open new markets to American
exports.
A sustainable fiscal policy requires more than just closing
the trillion dollar gap between federal spending and federal
revenues. A sustainable fiscal policy requires economic growth.
A growing economy improves our fiscal outlook by increasing
federal revenues and reducing federal spending relative to the
size of our economy.
Sadly, however, economic growth and job creation is lagging
under President Obama. To understand how poorly our economy is
performing compared with its potential, let's look at this
chart and compare the big government-oriented, I think, Obama
recovery to the free-market-oriented Reagan recovery.
From its low point in February of 2010 following the recent
recession, the Obama recovery produced private sector job
growth of 4 percent. Over the comparable time frame, the Reagan
recovery far eclipsed the Obama recovery with 10.1 percent
private sector job growth.
If President Obama had had the same growth rate of private
sector jobs as President Reagan enjoyed, we would have over 6.5
million more jobs today. That is more than one job for every
two workers currently counted as unemployed.
From its peak in October 2009, the unemployment rate has
declined by 1.9 percentage points under the President. Over the
comparable time frame, the unemployment rate dropped by 3.4
percentage points under President Reagan.
Under President Obama, the average GDP growth--real GDP
growth rate has been 2.4 percent over the 11 quarters following
the recession. Over the comparable time frame, President Reagan
delivered an average real GDP growth rate of almost three times
that amount, 6.1 percent.
More than anything, hardworking American taxpayers need
cohesive monetary, fiscal, and regulatory policies that
encourage business investment--business investment in new
buildings, equipment, and software. Joint Economic Committee
Republicans have shown that such private sector business
investment is the key to robust economic growth and private
sector job creation.
Leading economists believe that taxes affect the incentive
to work, the incentives to save, and invest. Thus, federal tax
policy not only determines how much the Federal Government
collects, but also how much the U.S. economy grows and how many
jobs are created.
Other economists seem to believe taxes don't really matter.
In their view, one tax increase to reduce the federal budget
deficit is just as good as another.
The purpose of this hearing is to examine the empirical
evidence offered by both sides of this thoughtful debate.
In his written testimony, Dr. Rogerson presents evidence
that taxes on labor substantially reduce employment and
economic output. When these taxes are used to fund transfer
payments and social services, the adverse effects on jobs and
economic growth are even greater.
Dr. Biggs presents evidence that these adverse effects
depend in large part on the specific tax and benefit rules of
each entitlement program. Older workers are especially
sensitive to the marginal net tax rate. That is the additional
after-tax income received in exchange for working and paying
taxes an additional year.
For his part, Dr. Johnson presents evidence that our taxes
are lower than they have been at times in the past; and they
are lower than many other countries' taxes today.
The question we face today is whether tax policy really
matters. Can Congress allow the tax reductions of 2001 and 2003
to expire without any adverse effects on jobs and economic
growth?
Would this be, as many leading economists and my Republican
colleagues have suggested, a ``taxmageddon''? Or, as President
Obama and many of my Democrat colleagues contend, can Congress
increase other federal taxes on the businesses and the
``wealthy'' with economic impunity?
Should Congress instead focus on fundamental tax reform and
carefully consider which tax policies will provide the greatest
boost to long-term growth and job creation in the private
sector?
Hopefully, today's hearing will help us answer those
significant questions. I look forward to the testimony of our
distinguished witnesses.
[The prepared statement of Representative Brady appears in
the Submissions for the Record on page 30.]
[Chart titled ``A Tale of Two Recoveries'' submitted by
Representative Brady appears in the Submissions for the Record
on page 31.]
Senator, would you like to make an opening statement?
Senator Bingaman. I did not plan to make an opening
statement. I appreciate the witnesses being here. I look
forward to hearing their testimony, and then I will have some
questions. Thank you.
Vice Chairman Brady. Thank you. And, Senator, thank you for
being here today, as well as the witnesses joining us at the
table.
I would like you to just be aware that we are reserving
five minutes for the written testimony, or for the verbal
testimony. We want to make sure your full testimony is written
into and subjected into the record.
With that, Dr. Rogerson, you are recognized.
STATEMENT OF DR. RICHARD ROGERSON, PROFESSOR OF ECONOMICS AND
PUBLIC AFFAIRS, PRINCETON UNIVERSITY, PRINCETON, NJ
Dr. Rogerson. Thank you.
So I would just like to make a few verbal comments
summarizing what was in my written testimony, consistent with
just the comments we heard.
My written testimony is concerned with the basic question
of long-run size of government, the activities the government
is involved in, how they are financed, and what the
consequences of that are for the overall performance of the
U.S. economy.
Most importantly, the issue is the size--government needs
to be financed. As a practical matter, most of the financing of
government comes from taxation on labor. And a key question is:
To what extent do taxes on labor provide a disincentive for
individuals to work?
We all know that in terms of our material wellbeing in the
United States, that is critically related to the level of
economic activity. Labor input is a key input into producing
output in the U.S. economy.
If we have policies which discourage people from working,
that will reduced the amount of output produced and lead to
lower material standards of living. So that is the issue.
I want to start with--I am going to basically talk about
some empirical evidence--but before i do that, I do want to
make one small comment about the kind of underpinnings in
economic theory. And I think this is critical, for the
following reason:
There is a tendency I think for people to talk in
generalities about taxation on labor, as if you tell me what
the tax on labor is and I can tell you what the effects are,
and there may be controversies about that.
What I want to emphasize is that economic theory tells us
very clearly that, if you want to think about the effect of
what taxes on labor income do to economic activity, you have to
also talk about what the revenues from that labor taxation are
being used for. And in particular, I will contrast two
different types--two different scenarios.
One scenario is when the revenues are being used either as
direct cash transfers--for example, things like unemployment
insurance, disability, social security; or, alternatively, I'll
say something like defense, which is not something that
individuals would necessarily go out and buy on their own if
the government were not providing it.
The theory tells us that the large effects we find are when
the labor revenues are being used to fund transfer payments,
either cash transfers to individuals, or provision of services
that people would have purchased on their own.
So when we look for evidence of labor taxes on economic
activity, we have to do it with an eye towards how revenues are
being used.
Now having said that, where should we look for evidence?
Economists to a large extent make their living by trying to do
very detailed studies based on extensive data sets. What I want
to simply point out here is, I think the simplest, most
transparent place to look for data is what economists call
``natural experiments.'' We would like to find a situation in
some country where there was a sizeable increase in the taxes
on labor used to fund transfer payments, holding everything
else constant. That would give us kind of clean evidence of
what happens in response to those types of effects.
In reality, it is relatively difficult to find those types
of clean experiments. One of the issues which I think has
clouded the inference that people make from making at the data
is some people look at the U.S. historical record, the last 50
years. They claim that there are different times when there
have been changes in taxes on labor, and they try to infer from
what they saw happening in the U.S. data what the effect of
those taxes are.
But in fact, in the U.S. the changes in those taxes have
been relatively small. There are all kinds of other things that
have also gone on in the U.S. economy--in particular,
demographic change, the entry of women into the labor force for
I think reasons unrelated to taxes which cloud conclusions. So
in my testimony, what I argue is the best source of evidence
for people in the U.S. is to actually look outside the U.S.
where other countries have had much larger changes in labor
taxation to fund transfer programs.
In my testimony I talk about looking at a study of 15 OECD
countries between 1960 and 2000. And just as a punch line that
comes out of that, I find that a 10 percentage point increase
in taxes on labor used to fund transfer payments is consistent
with a decrease in labor supply of about 12.1 percent.
This, in terms of a simple experiment, if there was a small
increase in the size of the U.S. Government funded by labor
taxes, the magnitude of the jobs lost is similar to the jobs
lost during the most recent Recession.
I will stop there.
[The prepared statement of Dr. Richard Rogerson appears in
the Submissions for the Record on page 32.]
Vice Chairman Brady. Thank you, Dr. Rogerson. Dr. Biggs.
STATEMENT OF DR. ANDREW G. BIGGS, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE, WASHINGTON, DC
Dr. Biggs. Vice Chairman Brady, Senator Bingaman, Members
of the Committee:
Thank you for the opportunity to testify today with regard
to the effects of taxes and transfer payments on labor supply
and employment.
The 12.4 percent Social Security Payroll Tax on earned
income is the largest tax paid by most Americans. Social
Security benefits, which are paid in exchange for payroll
taxes, are the largest source of income for most retirees. The
potential for Social Security taxes and benefits to influence
labor supply decisions is obvious.
The theory of Optimal Taxation states that taxes should be
highest in circumstances in which individuals are least
sensitive to the tax, and lowest when individuals are most
sensitive to tax rates.
Following this rule will tend to minimize the harmful
effects of taxation on work and the economy. Social Security's
treatment of older workers is precisely the opposite of what
economic theory recommends.
Social Security pays the lowest reward to work to older
workers who are near to retirement. These individuals, research
indicates, are almost the most sensitive to tax rates because
they have the easiest option to leave the workforce and retire.
The conjunction of high effective tax rates on particularly
tax-sensitive individuals leads to suboptimal outcomes for
individuals and for the economy as a whole.
Social Security's benefit formula is roughly actuarially
fair for individuals who choose to delay claiming benefits.
However, Social Security is not actuarially fair with regard to
the extra taxes the individuals pay when they delay retirement
and remain in the workforce.
Most near-retirees who extend their work lives receive
little or no additional benefits for any extra taxes they pay.
There are three reasons for this.
First, Social Security benefits are based upon an
individual's highest 35 years of earnings. So an additional
year of work is unlikely to boost benefits.
Second, most female retirees receive a spousal benefit
based upon their husband's earnings. So any additional taxes
they pay rarely lead to higher benefits.
Third, once individuals reach the full retirement age, they
are ineligible for Social Security Disability Benefits but
must, nevertheless, continue to pay the 1.8 percent Disability
Payroll Tax.
In a 2009 research paper with David Weaver and Gail Reznick
of the Social Security Administration, I found that for each
dollar of additional taxes a near-retiree pays into Social
Security, he or she receives back only around 2.5 cents in
extra lifetime benefits.
Simply put, Social Security provides almost no incentive to
keep working. This would not be of major policy importance if
near-retirees were not so sensitive to tax rates.
A middle-aged worker with a family to support may continue
working even in the presence of high implicit tax rates. But
once he or she reaches age 62, the option to retire becomes
more attractive.
Moreover, most retirees receive pension and Social Security
benefits which can increase the marginal income tax rates they
pay on earned income. Economic research finds that older
Americans are significantly more sensitive to after-tax rewards
to work than younger workers.
I have proposed reducing or eliminating the Social Security
Payroll Tax for older workers as an incentive to remain in the
workforce. Doing so would lower Social Security tax revenues,
but an increased labor supply from older workers would raise
other revenues such as for federal income taxes, Medicare
Payroll taxes, or state income taxes.
Eliminating the Payroll Tax for workers over age 62 would
reduce annual Social Security revenues by roughly 2.2 percent,
or about $16.2 billion in terms of today's tax collections.
Using parameters from research by Eric French of the
Federal Reserve, eliminating the Payroll Tax at age 62 would
increase overall labor supply by around 1.4 percent. A larger
workforce would increase federal income and Medicare taxes by
around $14.7 billion, with an additional increase of state
income tax revenues of around $3.6 billion.
In other words, eliminating the Payroll Tax rate on older
workers would effectively pay for itself through additional tax
revenues. While eliminating the Payroll Tax for older workers
would come at little cost to the budget, the gains to
individuals and the economy could be substantial.
Simply working one additional year would boost average
private pension income by almost 5 percent. This would reduce
poverty in old age and contribute to overall retirement income
security.
Social Security's poor returns to older workers discourage
delayed retirement which would strengthen the economy and it's
the single best option available to many individuals who reach
retirement age with insufficient savings.
Policy options such as lowering the Payroll Tax rate on
older workers could increase labor supply, boost the economy,
and raise retirement incomes.
Thank you, very much.
[The prepared statement of Dr. Andrew G. Biggs appears in
the Submissions for the Record on page 44.]
Vice Chairman Brady. Thank you, Dr. Biggs. Dr. Johnson?
STATEMENT OF DR. SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF
ENTREPRENEURSHIP, SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS
INSTITUTE OF TECHNOLOGY, CAMBRIDGE, MA
Dr. Johnson. Thank you very much.
I would like to make three points:
First of all, considerable damage has been doing to the
balance sheet of the United States over the past decade and a
half under a most unfortunate combination of circumstances. As
a result, if we are to put ourselves onto a more sustainable
and less fragile fiscal path, we need to restore revenue.
By the end of the 1990s, there was a relatively robust
revenue system in the United States. Since that time, we had
large tax cuts in the beginning of the 2000s, two foreign wars,
Medicare Part D, and most unfortunately the financial crisis.
The Congressional Budget Office estimates that the net
impact of the financial crisis on our debt relative to GDP over
the cycle is to increase it by about 50 percent of GDP. Call
that $7.5 trillion in today's money.
This is the situation that we find ourselves in today. And
I think that the parallel with the situation in the mid- to
late 1980s under Ronald Reagan is apt. President Reagan
recognized under those circumstances with pressure from--
perceived pressure from the bond market, and concern about the
predominance of the United States and the role of the U.S.
dollar, he and his Administration agreed with Congress on the
need for strengthening revenue. And I think that is the moment
which we find ourselves in today.
Now with regard to where you should get the revenue and the
effects of that, I agree with Professor Rogerson that we should
look for natural or quasi-natural experiments. And I accept his
caveats about how difficult it is to find this in any
historical experience, including across the OECD.
I would point out--and I have written at length, both in my
testimony and in a recently published book on the effects of
the Bush-era tax cuts--that the effects of those tax cuts, the
reduction in higher marginal income tax rates, reduction in
estate tax, and a number of other tax reductions, did not have
major stimulative effects in terms of increasing labor supply,
boosting productivity, or otherwise moving trend growth in the
United States.
It is not perfect evidence, to be sure. But if we are
talking about realistic ways in which revenue might be raised
in the near term, I think not extending the Bush-era tax cuts
is absolutely going to be on your agenda. And I would encourage
you to look at that seriously.
That revenue is available. Going back to the revenue system
of the late 1990s, again not a perfect system, no tax system is
perfect, but that is an absolutely feasible and attainable
political choice.
The evidence--and we reviewed this evidence that was also
compiled during the George W. Bush Administration--evidence
that these tax cuts would pay for themselves, or stimulated,
moved trend growth in the ways that, Mr. Brady, you outlined,
we absolutely have to do in this country, that evidence is very
limited.
Now the third point I would make is with regard to the
international context. I am the former--among other things--the
former Chief Economist of the International Monetary Fund, and
I would like to impress upon you the fragility of the European
situation today.
I think that it will be very dangerous for the world,
including for our export markets, including for financial
markets with which we are deeply interconnected, if we have any
kind of fiscal crisis, or perceived fiscal crisis, in the
United States.
Refusing to raise revenue, or signalling that revenue is
absolutely not on the table under any circumstances, can be
read in a very negative manner by financial markets. These
markets can turn against us very quickly.
I would remind you that the impact of the controversy and
debate over the debt ceiling last year, while it did not
increase yields in the United States for government bonds, it
did absolutely put pressure on weaker countries around the
world, including in Europe.
The last thing the Europeans need right now is further
disruption to financial markets, and a more difficult
environment for their government bonds.
If the United States were to take steps in a reasonable
compromise--and there are a range of compromises already on the
table, and we propose other versions in our book--with some
combination of raising revenue, including through high tax
rates, and controlling future spending, that would send an
enormous signal to world financial markets. The U.S. would be
propelled back to its, until recently, unquestioned predominant
role in the world economy. We would again become a bastion of
financial stability.
That would be a tremendous contribution towards European
financial and fiscal stability. And I urge you to take
seriously--consider seriously the policy that would lead us
towards a more balanced approach to restoring revenue and
underpinning fiscal stability and bringing the debt to GDP
under control in the United States.
Thank you very much.
[The prepared statement of Dr. Simon Johnson appears in the
Submissions for the Record on page 47.]
Vice Chairman Brady. Thank you, Dr. Johnson.
Can I ask my fellow members for a point of privilege here?
I was remiss in not keeping with me the bios of our three
distinguished witnesses today. I would like to briefly tell you
about the people we just heard from because I think it is
important.
Dr. Richard Rogerson is a Professor of Economics and Public
Affairs at Princeton University. He also serves as co-editor of
The American Economic Journal Macro Economics and is Associate
Editor of Review of Economic Dynamics. He previously served as
co-editor of the American Economic Review and Associate Editor
for the Journal of Monetary Economics. He is a Visiting Scholar
at the American Enterprise Institute; a Research Associate at
the National Bureau of Economic Research; and a Fellow of the
Econometric Society.
Dr. Rogerson, thanks for traveling to be with us today.
Dr. Biggs is a Resident Scholar at the American Enterprise
Institute here in Washington. His work at AEI focuses on Social
Security reform, as is clear from his testimony; state and
local government pensions, and comparisons of public and
private sector compensation. Prior to joining AEI he was a
Principal Deputy Commissioner of the Social Security
Administration. In 2005 he worked on Social Security reform at
the National Economic Council. In 2001 he was on the staff of
the President's Commission to Strengthen Social Security.
Dr. Biggs, thank you.
Dr. Johnson, I would like to welcome as well. He is the
Ronald A. Kurtz Professor of Entrepreneurship, Professor of
Global Economics, and management of MIT's Sloan School of
Management. He is also a Senior Fellow at the Peterson
Institute for International Economics, a member of the
Congressional Budget Office's Panel of Economic Advisers; and a
member of the FDIC's Systemic Resolution Advisory Committee,
among other honors.
Dr. Johnson, thank you for being here.
Let me get to the heart of the matter.
[Pause.]
Votes have been called. We will be brief. I thought all
three testimonies were very interesting.
Dr. Biggs, if more seniors read your analysis of the cost/
benefit analysis of working late in life and Congress does not
take steps to reform, I think we have got a bigger challenge on
our hands with Social Security than we do today.
Dr. Rogerson, your point goes to the heart of does taxation
on labor matter. Your point is that over the last 40 years,
that labor taxes in America--or frankly, labor taxes among our
OECD competitors, have risen at three times the rate of the
United States.
As a consequence, worker hours worked among those same
competing countries, while ours have increased, on average our
OECD competitors' hours have decreased. And it has a direct
economic consequence as a result.
You make the point that if the tax rate on labor is
increased by 10 percentage points, hours of work will decrease
by 12.1 percent.
Another way to look at tax rates is to calculate the after-
tax return. My question is: If the tax rate is 25 percent, and
the after-tax return is 75 percent, I asked my staff to
recalculate your data on that basis. They concluded that a 10
percent change in the after-tax return to labor would result in
12.1 percent change in hours worked. Would that be consistent
with your results?
Dr. Rogerson. Yes, definitely. Those are two different ways
to summarize the patterns that are in the data. So those two
estimates are in fact consistent with each other.
Vice Chairman Brady. And the net result is if you raise
taxes on labor you get less of it and fewer jobs as a
consequence?
Dr. Rogerson. Yes. With the caveat that the--it depends
what the revenues are being used for----
Vice Chairman Brady. Sure.
Dr. Rogerson [continuing]. And across countries the
revenues are being used either for transfer payments, or
provision of services in kind. So that is implicit in those
estimates.
Vice Chairman Brady. Sure. Right. Thank you. I wanted to be
brief because of the vote.
Senator Bingaman.
Senator Bingaman. Since there is a vote on the House side,
maybe you would want some of the House Members to go ahead with
their questions, because we do not have a vote and I can stay
when you folks have to go vote.
Vice Chairman Brady. Great. Thank you, Senator.
Dr. Burgess.
Representative Burgess. Yes, we have noticed they do not
vote often in the Senate.
[Laughter.]
Sorry. I couldn't resist.
Let me just ask a question because it is the point of some
discussion. The Speaker gave a speech yesterday at the Peterson
Foundation and talked about the fact that we all knew December
of this year was likely to be a pretty dreadful month, and it
is his opinion that we ought to move things out of the so-
called lame duck session and tackle those problems during the
time that we have left, between now and the election. And I
agree with him.
I may not agree with everything that he outlined, and I
rather suspect our panelists do not agree with everything that
he outlined, but fundamentally do you think that is a more
coherent approach to the problems that face this country? What
with the expiration of existing tax policy, the Bush-Obama tax
cuts, the possibility of facing yet another debt-limit crisis
toward the end of the year, should we move this forward and get
it done during the summer, or during the early fall? And I
would appreciate an answer from each of you.
Yes, Dr. Rogerson, we will start with you and then move
down.
Dr. Rogerson. Okay. I mean, my view on that issue is I
believe uncertainty is bad for the economy. And so when there
are important decisions to be made, rather than let them sit
and people be worried about what may happen, I think it is
important to take action. So from that perspective, taking
action sooner so that individuals and businesses can understand
what they're going to be working with moving forward, I think
that makes good sense.
Representative Burgess. Right. It is not like these things
are not going to happen.
Dr. Biggs.
Dr. Biggs. I agree with Professor Rogerson regarding
uncertainty. I think I would just add that I am not an expert
on the political process, but it strikes me that the longer
people from both parties have time to consider the sorts of
choices and the sorts of compromises they might have to make,
the more likely it is an agreement can be come upon.
So beginning today, and talking as much as you can today, I
think is more likely to produce a good outcome than pushing it
all to December and then trying to rush it through at the end.
Representative Burgess. Well that is typically what we have
done.
Dr. Johnson.
Dr. Johnson. I think it depends on what sort of deal you
think you could come up with in the interim, Dr. Burgess. If
revenue is on the table. If you have a balanced approach to
bringing the debt under control, this would amazingly shock and
impress world financial markets. And you would substantially
remove the risk of a fiscal crisis in this country for the
foreseeable future.
But if revenue is completely off the table, if this kind of
debate would just reaffirm that, that one part of the political
spectrum will not compromise or change its view with regard to
tax rates and bolstering revenue, then I fear that the
financial markets may take that adversely. So you would resolve
the uncertainty, to be sure, but resolve it in a negative
direction with regard to medium-term fiscal sustainability.
Representative Burgess. Let me just ask you a question, Dr.
Johnson. In your testimony you said that the expiration of
existing tax policy would be desirable.
Now when the President talks about it, he talks about
preserving existing tax policy for people who earn under
$250,000 a year for a couple. Is it your view that the entire
existing tax policy from 2001d 2003 needs to go away?
Dr. Johnson. Yes. What exactly our view is is that the so-
called Bush-era tax cuts--perhaps we should call them the Bush-
Obama tax cuts now--should not be extended. And if you feel
that the effect, short-term effect on the economy would be too
dramatic, I would propose that you replace that with a
temporary payroll tax linked to employment relative to total
population.
So as employment recovers, the payroll tax would fade away.
That is a way to offset the anti--if you want to be Keynesian
about it, and I do not particularly urge a Keynesian
perspective here, but if you want to take a Keynesian
perspective then you could replace the effects of those
expiring tax cuts with the temporary payroll tax cut linked to
a rule.
Representative Burgess. Well suffice it to say we are not
going to come to a conclusion today, but I appreciate all of
your views on that. And this is something that again I am glad
the Speaker brought it up because we do need to face it.
Although it may be politically unpalatable to do so before
election day, it needs to happen.
I will yield back, Mr. Chairman.
Vice Chairman Brady. Thank you, Dr. Burgess.
Mr. Mulvaney.
[No response.]
Mr. Duffy.
Representative Duffy. Thank you. I want to be clear, Mr.
Johnson, as well. When we--we talk about allowing the Bush tax
cuts to expire, how much revenue would that bring in in the
first or second year of that expiration?
Dr. Johnson. Well the usual time frame for the numbers used
are $4 trillion over 10 years. And roughly speaking, you would
expect that to be evenly spread over the 10-year period. So
that is a substantial amount of revenue.
But the key thing, and the contrast that I would emphasize
between our situation and let's say the European situation, is
that we do not need to make a precipate, immediate fiscal
adjustment. We have time to get our debt onto a more
sustainable path.
I recommend bringing debt down to 40, 50 percent of GDP.
And as a result, taking that revenue more gradually through
some sort of offsetting temporary tax cut could also be
considered to be entirely reasonable fiscal policy. The point
is to change the medium-term forecasted future.
Representative Duffy. So roughly, you're saying, about $400
billion a year, is that right, would come in in revenue for
these increased tax rates?
Dr. Johnson. That is the standard CBO calculation.
Representative Duffy. And the rest would come from tax
cuts? I'm sorry, spending cuts? You're proposing spending cuts
as well, right?
Dr. Johnson. We are proposing to limit future increases in
spending and, at least in our framework you do that over a two-
decade horizon. So you can phase in some of those spending
cuts. You can also begin to limit tax expenditures.
Representative Duffy. Is that Medicare reform? Social
Security reform? Is it the military? What do you guys look at?
Dr. Johnson. All of the above.
Representative Duffy. Okay. And in your analysis, when we
allow tax rates to increase there is an offsetting impact on
the economy? Isn't that right? The economy does not grow more
with tax increases? It would probably grow less? Is that right?
Dr. Johnson. Presumably--look, nobody likes high taxes, and
higher taxes must have some distortive effect. But the question
is: How much effect do they have?
This is not a high-tax country. These are not--we are not--
our experience with these tax rates is not consistent with the
view that they have caused a major slowdown.
Representative Duffy. But you would agree that if you raise
taxes, that that will have a slowing effect on the economy? It
does not grow the economy more? It would grow it less?
Increased taxes, yes?
Dr. Johnson. Well actually in the standard CBO framework,
the question is: What is the medium-term picture for the
deficit?
So if you are cutting taxes and have a larger deficit as a
result, that in the CBO framework will actually slow growth
because you are crowding out private investment as you issue
more government debt.
Representative Duffy. Is your testimony, then, that if we
raise taxes we will increase American growth?
Dr. Johnson. My testimony is that what you need--as the
Chairman said at the beginning--is a sustainable fiscal future
consistent with economic growth. And in order to do that, you
should constrain, for sure, future spending; and strengthen
revenue in part by increasing tax rates.
Representative Duffy. And isn't the best way to strengthen
revenue to the federal coffers a growing economy? I mean,
doesn't a growing economy have a far better impact on revenues
to the federal coffers, as opposed to tax increases?
I mean, if you look at correlations in American history
with regard to growing economies and tax increases, don't you
have a better correlation with growing economies which mean
more people are working, more people are making more money,
which means more people are paying taxes? As opposed to raising
tax rates?
There is not that correlation, is there?
Dr. Johnson. Of course we want to have economic growth. But
as the Europeans have discovered, if you run persistent
deficits and you refuse to fund the government on a responsible
basis, you get a fiscal crisis. Bond yields go up. Private
credit contracts. That is the worst possible thing to do for
economic growth.
Representative Duffy. And I would say that we are in a
global economy. I think it has changed over the course of the
last 10 or 12 years. There is far more competition from India,
China, Mexico, Vietnam, Brazil, Canada. And I guess I would
look at it like this:
You know big box retailers, right? Wal-Mart, Target, Kmart?
If you were to advise Kmart today, you say: Kmart has to bring
a little more revenue to keep their stores open. Your advice to
Kmart would be to bring in more revenue, you would have to
raise the price of the goods that you are selling by 2 percent,
5 percent. And if you raise your prices of the goods sold, that
will bring in more revenue.
But everyone here knows that if Kmart raises its prices,
right, you will see shoppers go to Wal-Mart and Target. If we
raise the price of doing business in America, doesn't that also
drive business elsewhere in the world from American shores to
China, India, Mexico, other parts of the world that are more
competitive?
Dr. Johnson. Congressman, we certainly have to worry about
competitors. You are absolutely right. It is a globalized
world, and globalized financial markets. If the financial
markets decide that you do not have a responsible fiscal
policy, if they are concerned about the sustainability of your
debt, that is the worst shock of all. That is where the
Europeans are.
These are rich, proud countries. These are our competitors
in Europe who have inflicted upon themselves an awful fiscal
disaster that absolutely is going to undermine growth for the
foreseeable future. We do not want to go there, and we do not
need to.
Representative Duffy. And I would agree with that. But I do
not think we get there by raising--I mean, I think we have done
a study here where you could raise your top tax rates on the
two top brackets to 100 percent and you still could not balance
your budget.
So we think we have to grow our economy, number one, and
reduce our spending. And my time is up and I yield back.
Vice Chairman Brady. Thank you, sir.
The House Members will be going back to the Chamber to
vote, and I will yield to Senator Bingaman for questioning.
Thanks.
Senator Bingaman [presiding]. Thank you very much.
I am advised that I should ask my questions, and then we
will put the hearing in recess until the Vice Chairman Brady
can return. And he will be back in just a few minutes, as soon
as they vote in the House.
Let me ask a couple of questions that have occurred to me,
just hearing the discussion here. If the concern is to have a
robust, growing economy, raising taxes can interfere with that;
cutting spending can, as well. The proposed spending cuts would
also drag down our economic growth, as I understand it.
Are those two roughly comparable in the effect? In other
words, do policies that raise additional revenue through tax
increases and policies that cut spending have a comparable
effect on the growth rate of the economy?
Dr. Johnson, I would ask you first.
Dr. Johnson. Yes, Senator, in the short term they are
roughly comparable. If you consider what the European
discussion is right now about austerity, in some European cases
they are cutting spending. In other European cases, they are
raising taxes.
If you do either one of those in a forced, precipitant
manner, that will, generally speaking, have a contraction
effect on the economy, depending on what else is going on.
Over the medium term, the task of the United States is to
control spending, control it as a percent of GDP; not to cut it
dramatically in a way that would damage the economy. Control
spending and make sure that it is funded more completely with
revenue.
We have relied a lot on issuing debt in the past decade-
and-a-half. Half of our national debt is now owned by
foreigners. That is not a sustainable situation. Sooner or
later the Asian economies and oil-producing economies will save
less and/or there will be competing currencies in which people
can put these investments when they want to invest
internationally.
We should have a more sustainable funding basis for the
activities of the Federal Government, including the social
insurance programs--Social Security, Medicare, other forms of
health care funded through the government in the form of
insurance for people who cannot afford health care otherwise.
That has to be funded on a sustainable, realistic, and
reasonable basis.
Senator Bingaman. Let me ask about payroll tax cuts. The
conventional wisdom here in Washington is we are not going to
extend the payroll tax cut at the end of this year, when it is
due to expire. The President's budget does not propose to
extend this tax cut beyond 2012, and Members of Congress have
given speeches saying the payroll tax should go back to where
it was, 6.2 percent on the employee, 6.2 percent on the
employer. It still is 6.2 percent on the employer right now.
But they are saying at the end of this year, we should go back
to that level of taxation on employees.
The debate is now about what do we do about the income tax
cuts--the so-called Bush tax cuts or as some have called them
today the Bush-Obama tax cuts since they were extended a couple
of years under President Obama.
My impression is that if you want to maximize employment in
a society, you would try to find a way to keep the payroll tax
as low as possible, and you would get your revenue from
somewhere else on an ongoing basis.
I know that the argument is made now that we've got to go
back to the previous level of the payroll tax in order to fund
the Social Security Trust Fund, but there are bound to be
alternative ways to put funds into the Social Security Trust
Fund if the economy would benefit substantially from keeping
the payroll tax low on the workers themselves.
Dr. Rogerson, do you have some thoughts about whether it
makes sense for us to contemplate some way to keep the payroll
tax from going back to where it was?
Dr. Rogerson. The main comment I would make is that in a--
there are issues about what happens in the immediate aftermath
of the change in terms of how long it takes various prices and
such to adjust from a long-run perspective, conditioned upon
talking about raising money from taxing labor whether it is
labor income tax, the establishment part of the payroll tax, or
the worker side of the payroll tax, to first approximation I
view all of those as the same.
Senator Bingaman. So with regard to the long-run effect on
the economy, it does not matter whether we get the revenue from
letting the payroll tax go back to where it was, or get the
revenue from increasing the income tax?
Dr. Rogerson. Yes. As I say, the first approximation there
are--if we go into additional level of details, there are some
distributional consequences because of the structure. So there
are issues about if you are just increasing the payroll tax in
its current form, of course it is capped at a certain income.
If you are talking about changing the income tax on labor,
there is the question about how you do that across the income
spectrum. But assuming you are sharing the burden of that
taxation equally in the two systems, whether it comes from
payroll or taxing income from labor I say is neutral.
Senator Bingaman. Yes, Dr. Johnson.
Dr. Johnson. Well, Senator, as you know, the original
presentation of Social Security under President Roosevelt was
very much as a social insurance program; that you are paying in
and you are getting it out. We are insuring you against
outliving your other assets and your family's ability to
survive you.
And I think that that motivation and explanation for Social
Security is very important to keep in place. Social Security is
mildly regressive on the taxation side because we do not tax
all of your income, or even all of your labor income. I should
think the cap should be lifted, or indexed more appropriately,
but not removed completely.
And it is a somewhat progressive policy on the receipt of
Social Security. So it is a mildly progressive, but not
massively progressive, or redistributive policy. And I do not
think you should shift the burden of financing that away from
the payroll tax onto income tax, where income taxes, as you
know, are paid more by middle income and higher income
Americans.
I think people value the fact that they are paying into the
system, and they get out a form of social insurance both for
Social Security and for Medicare. Medicare is the same
motivation. We are insuring you against ill health when you are
in your 70s, 80s, and 90s, because there has never been private
insurance that will cover you for those risks, and there never
will be, irrespective of what you try and do to the health care
system. Those are uninsurable risks from a private perspective.
Therefore, you have a social insurance program which you fund
appropriately.
Senator Bingaman. Let me ask both Dr. Rogerson and Dr.
Johnson to give me their reaction to the proposal that Dr.
Biggs has made. As I understand it here, it is essentially
saying that the payroll tax should not apply to a person when
they reach the age of 62 and are then eligible for Social
Security. He sees benefits in keeping people in the workforce,
allowing them to build up additional pension, value if we
provide that incentive. He says the current system of payroll
tax, as I understand it--and correct me if I am misstating your
position, Dr. Biggs--but as I understand what your point is,
that the current payroll tax is a disincentive for folks who
stay in the workforce once they are 62 years old? Is that
accurate?
Dr. Biggs. That's correct. For younger individuals, the
payroll tax shouldn't be a significant disincentive because
they're aware that they are earning benefits that compensate
for the taxes they are paying.
For people who are near retirement, on average they earn
almost no additional benefits. So the Social Security Payroll
Tax would be what you would call a ``pure tax.'' It is money
they pay that they are never going to get back. When you have
the option of retiring, that makes retiring seem more
attractive relative to working.
Senator Bingaman. And your proposal is that at age 62 they
would no longer be required to pay the worker's portion of the
payroll tax? Is that what you are suggesting?
Dr. Biggs. To make the system actuarially fair for
individuals in that age range, you would have to eliminate both
the employee and the employer side of the tax, the full 12.4
percent.
Senator Bingaman. I see. So what is your reaction to that
kind of proposal, Dr. Rogerson?
Dr. Rogerson. I guess the most general comment I would make
is that, as Dr. Biggs has testified, the details of benefit
programs such as he is talking about I think are very
important. They can have very large incentive effects.
Just to draw on some cross-country evidence, the U.S.
system of paying out is quite different than what exists in
some other countries. In some countries, for an individual to
receive their social security they actually have to stop
working at their existing job.
A system such as that creates a huge incentive for
individuals to stop working at a point where the benefits that
are eligible to them have been maxed out and may well be as
large as the income they get from their job. There is simply no
benefit to working.
So I think those types of institutional details exist in
other countries. What Dr. Biggs has talked about is that type
of detail. It is a little bit of a smaller scale in the context
of the U.S. system, but I agree with the idea that we need to
be very careful about the incentives for work as they apply to
workers in those situations.
Senator Bingaman. Dr. Johnson, did you have a point of view
on Dr. Biggs's proposal?
Dr. Johnson. Well I agree that we should encourage people
to work longer. And one of our proposals is, in the context of
strengthening Social Security and raising revenue to support
it, we should also index the age at which you can receive a
full pension to life expectancy.
Americans who are 65 today should expect to live 3 years
longer--this is on average--3 years longer than Americans who
were 65 in 1970. So, roughly speaking, Americans could retire
one year--under our proposal, retire one year later every
generation, one year later than your parents retired.
Senator Bingaman. So you are saying that that indexing
should occur with regard to Social Security benefits?
Dr. Johnson. With regard to the age at which you could
receive a full pension, not the age at which you can begin to
receive a pension which would remain at 62.
Now on Dr. Biggs's proposal, which I think is interesting,
I need to study it further. I think I would have some questions
about the behavioral basis on which people make this decision
of whether to continue working when they are older.
Certainly some older Americans take the view that they are,
through the additional income they are earning from their job,
that they are helping to protect themselves against let's say a
tail outcome of living a very long time. And there are many
Americans who want to continue to work until the age at which
they can absolutely get the maximum benefit.
So I think there is one issue of what is actuarially fair.
There's another issue of the basis on which Americans, older
Americans, make those decisions. And I think we should look at
that.
We have had great success in extending life expectancy. We
need to avoid becoming a society in which people retire younger
and younger. That is one of the mistakes that has been made in
Europe. We have not gone that route. I think we need to push
gently in the other direction at the same time as raising the
payroll tax over the medium term in order to help rebalance the
Social Security Trust Fund.
Senator Bingaman. Let me ask Dr. Johnson, just so I clearly
understand what you suggest in your testimony. Your suggestion
is: Allow the Bush tax cuts to expire at the end of the year,
as they are scheduled to, and in order to be sure that you do
not have too adverse an effect on the economy, we should have
some kind of a reduction in the payroll tax that would be
linked to employment, and the total population? Maybe you could
just explain how that, how the two would interact, and what the
trigger would be for getting the payroll tax back to where it
is today, or where it is scheduled to be?
Dr. Johnson. Certainly, Senator. And this proposal, I
should say, has also been made by Peter Orszag, who was the
former Budget Director in the Obama Administration and a former
head of the Congressional Budget Office. The idea is that the
payroll tax would be--you would cut the payroll tax, and you
would phase it back in based on employment relative to total
population.
You don't want to do it----
Senator Bingaman. Cut it from what it is today? Or from
what it will become on the first of January if we do not change
the law?
Dr. Johnson. Well from what it is today. If you want to
have a stimulative effect relative to what it--that should be
taken as the appropriate baseline. But you want to restore it,
eventually, to the rate at which it was before, or we are
actually suggesting that the payroll tax rates should gradually
over a period of decades actually increase as a way to
rebalance the Social Security Trust Fund.
And the key point is, Senator, not to link this to
unemployment because the number of people who are unemployed
depends on how the labor market is. People get discouraged.
They drop out of the labor force. And that reduces
unemployment. What you really want is to get people back to
work. You want to restore employment back to where it was
preferably before the financial crisis of 2008.
So the temporary payroll tax cut would be phased out as
employment rises relative to the total population. There would
be a formula, a rule that you would set in law, and then you
would hope that subsequent Congresses did not overturn that
rule. And if people believe you are not going to overturn it,
then you have a credible path towards medium-term fiscal
sustainability at the same time as you preserve what people may
feel is a stimulative effect of the tax cuts.
Senator Bingaman. Dr. Rogerson, did you have a point of
view as to what the Congress ought to do at the end of the year
on the Bush tax cuts, on the payroll tax change? Or any of the
other crises that we are expected to confront here at the end
of the year?
Dr. Rogerson. I have a very boring answer to that. I do not
have a strong view on those particular things, piecemeal. I
think what is critical is to have a long-range, coherent view
of what programs are going to be supported and how they are
going to be financed.
And to talk piece by piece about each one individually I
think is actually counterproductive, and in some ways it is
hard--ultimately, we need to talk about the package of things
that the government is going to do and how they are going to be
financed. And you can't parcel out the effects of things one by
one without knowing what is going to be adjusted to compensate.
So that is my boring answer.
Senator Bingaman. Dr. Biggs, did you have a point of view?
Dr. Biggs. Well I agree with Professor Rogerson's view that
you want to think in terms of package deals, in the sense that
we have to think of what we want government to do for us and
what we are willing to pay for it.
With regard to the Bush tax cuts, though, I think it is
worth pointing out, there is a perception that the Bush tax
cuts have starved the Federal Government of revenue. And if you
look historically, if you look at CBO's projections going
forward, I think that is just really not the case.
I mean, historically the Federal Government has collected
total revenues equal to somewhere around 18 percent of GDP. I
don't have the precise figures in my head, but that is about
right.
If you look at CBO's projections of federal revenues going
forward relative to GDP, if you retain the Bush tax cuts they
rise to record levels relative to GDP. They are around 20
percent of GDP on average.
So certainly retaining the Bush tax cuts means less tax
revenues than getting rid of the Bush tax cuts. Does it mean
less revenues than we have lived with in the past? The answer
to that is: Clearly, no. We will have as much revenue relative
to the size of the economy as we have in the past.
And so the question we have to say is: Is that enough? Or
do we need more? But my main point is the idea that we are
being starved of revenue, pushed below historical levels by the
Bush tax cuts, I think is not correct.
Senator Bingaman. Dr. Johnson.
Dr. Johnson. Well the--just to Dr. Biggs's point, the
nature of society has changed fundamentally. It is an aging
society, and the major activities of the Federal Government, if
we are looking out over a period of decades, is maintaining and
running the social insurance programs, which as we discussed
involve individuals paying in when they are young and receiving
benefits, both pension and health care, when they are older.
So if you cap artificially spending levels at 18 percent,
or some other number, then you are squeezing the ability of the
people themselves to participate in the social insurance
programs run by the government. And I am not sure why you would
want to do that.
We should be ensuring that older Americans can have a
reasonable retirement with decent health. This is a great
achievement, one of the greatest achievements of this country.
I do not see why we want to undermine that.
Senator Bingaman. Well I have heard people refer to the
Federal Government as a big insurance policy with an army. And
maybe that is what we are headed toward here.
I think it has been useful. Thank you all for being here
and testifying. As I indicated before, Mr. Brady had asked that
you please stay around for a few minutes, if you would, until
he can return and ask a few more questions.
Thank you. We will go into recess here for a few minutes.
[A brief recess is taken.]
Vice Chair Brady [presiding]. Good afternoon, everyone.
Thanks for understanding the delay as we finished our House
votes. And we will have I think some of our Members returning
for questioning, as well.
I have a question for each of you.
Dr. Rogerson, I believe you are familiar with the 2010 CRS
Report that referred to the study you co-authored in 2006
published by the Federal Reserve Bank of Kansas City. Do you
think the CRS Report correctly stated the findings of your
study?
Dr. Rogerson. Absolutely not. The quote that I read in it
was basically the complete opposite of what we claimed our
findings were.
Vice Chairman Brady. Yes, that was my understanding. In
fact, when we asked CRS about this at our last hearing, they
admitted their report was in error. They then proceeded to give
us another description of your study. You may be familiar with
it. Do you agree with their latest description?
Dr. Rogerson. I do not. I have read their report and
personally find it quite puzzling to try and make sense of the
arguments being made in relation to what we have done. In
particular, our study and the testimony I presented today are
very clear about the important role of how tax revenues are
used. To return to the language of kind of intermediate micro,
there's income and substitution effects. If you tax somebody,
there's an income and a substitution effect. When you give it
back as a transfer, that undoes the income effect. You are left
with a substitution effect. That is critical to the results,
and they do not seem to appreciate that.
Vice Chairman Brady. Well be aware, I think CRS ought to be
accurate, especially in describing other studies. So we are
going to be asking for a correction, or at least an
acknowledgement that in future papers that your study is
described accurately.
People read these. They count on them. It matters. So thank
you, Doctor.
Dr. Rogerson. Thank you.
Vice Chairman Brady. Dr. Biggs, in your testimony you said
Social Security payroll taxes cannot be viewed in isolation. A
key point. Benefits also have to be considered. On a lifetime
basis, you say benefits are equal to 78 percent of the taxes
paid by a typical couple. But for those nearest retirement,
additional benefits are equal to only about 2.5 percent of the
additional taxes paid.
Do you think there is any evidence that workers are aware
of that significant disparity?
Dr. Biggs. Well, there's been some work done looking at how
well individuals understand the Social Security rules. And they
understand them a little bit better than my gut would tell me
would be the case, because the Social Security Benefit formula
was extremely complicated. And so no one can understand that in
full.
The general incentives though, I think they do understand.
And when I was at Social Security, I would occasionally talk to
people. And they would ask you: What am I going to get if I
continue working? And the answer I would have to give them is:
Well, pretty much nothing. I mean, your benefit will be
increased to account for the fact that you are delaying
claiming, but the taxes you pay between today and the eventual
date of retirement, very few people are going to get very much
of that back.
Vice Chairman Brady. You think overall they understand it
in a general sense?
Dr. Biggs. I think they do, yes. And their behavior
reflects that.
Vice Chairman Brady. As opposed to--explain that a little
further, ``and their behavior reflects that''?
Dr. Biggs. Well, I mean if you go back to the 1950s, the
typical person claimed Social Security benefits around 68.
Today they claim them earlier. And there's been changes in the
benefit rules, which I think would help push that. But I think
there's just kind of a gut feeling of, you know, what am I
getting out of this?
And when people are younger, younger folks in particular
don't think they're getting very much out of Social Security
but they don't have much choice. You know, if you want to eat,
you have to work. And so they are going to try to work
regardless.
When somebody is in a situation where they can retire,
though, if they do not feel the system is paying them back in
exchange for what they are paying into it, they are going to
take that option to retire.
One point I would make, in thinking about our budget
solutions going forward, is that raising the Social Security
payroll tax rate could exacerbate this in the sense that if you
raise Social Security taxes people's after-tax earnings are
going to be lower. And for near-retirees, the Social Security
benefit they could get is going to look more attractive
relative to what they could get by working.
So by doing that, we could push more people into
retirement. So there are going to be difficult choices involved
with Social Security reform, but we have an aging population.
If there are things we can do to keep people on the job and
keep them working, that is good for the economy. It is good for
the federal budget. And most of all, it is good for the people
who do it.
Vice Chairman Brady. Well can I, to follow up on that, in
your testimony you suggest one way to increase employment would
be to eliminate the payroll tax for older workers. The obvious
objection, which you identified as well, is a potential loss of
revenue.
Other people have suggested that we raise the retirement
age. The obvious objection there is most people want to retire
sooner rather than later, even though they are living longer.
So what about both? In your view, what would be the offset
of linking your payroll tax elimination to an increase in the
age of eligibility?
Dr. Biggs. Well you could do transfers from the rest of the
budget back to Social Security. In my testimony, I point out
that the increases in federal income taxes, federal medicare
taxes, and state income taxes, would roughly compensate for the
reduction in Social Security revenues.
So you could simply make transfers from the rest of the
budget back to Social Security. Alternately, you could----
Vice Chairman Brady. So the offset is obviously not within
the mandatory side of it, but it's in the general revenue?
Dr. Biggs. That's correct.
Vice Chairman Brady. From the economic growth.
Dr. Biggs. So Social Security, by cutting the payroll tax
rate, will lose revenue. The question is how much other revenue
do you gain? Do you want to compensate Social Security back for
it? I would tend to think you would.
Things like raising the retirement age, those will also
encourage people to work longer. There is evidence that as the
retirement age has shifted from 65 to 66, more people have
targeted that age 66 retirement age.
So I believe in sending a whole range of signals to people
that says, you know, you need to work longer but we want you to
work longer. Raising the retirement age is sort of the stick of
saying if you do not work longer you are going to get a lower
benefit. Cutting the payroll tax rate is the carrot. It says to
individuals, and it also says to employers, you know, we want
you to work. we want to make it worthwhile for you to do this.
Vice Chairman Brady. Do you think--I serve on the Social
Security Panel over in the Ways and Means Committee--you know,
the number of people choosing to retire at 62 is pretty
striking. When you talk with them, the first answer that comes
out is that, I don't know about the finances of Social Security
in the future; I'm frankly going to access my benefits now
while I can.
Do you think that is a part of the thinking, rational
expectations of a worker at that age?
Dr. Biggs. I think it's actually irrational expectations. I
think that many people are thinking that. They say, I'm going
to get it while I can get it.
Vice Chairman Brady. Yes.
Dr. Biggs. The political reality is, the chance of cutting
benefits significantly for current retirees, or near-retirees,
is pretty small. The only way you could really do that is by
cutting cost-of-living adjustments, and retiring earlier is not
going to fix that.
So I think that is something where workers are scared, and
they are retiring early when they really should not do that. So
I think by getting Social Security reform on the table, and
really discussing it, yes, it raises some tough choices that
people do not want to think about, but it can also reassure
people who are near retirement that we are not going to pull
the rug out from underneath you.
Vice Chairman Brady. Thank you, Dr. Biggs. Before I turn
the questioning over to Mr. Mulvaney, Dr. Johnson, this is a
little bit off-topic but since we have got you here I would
like to ask you a question about a topic you have written a
great deal about: Too big to fail.
Do you believe that Dodd-Frank has helped protect our
economy from systemic risk? Or simply made the problem perhaps
even bigger and potentially more problematic?
Dr. Johnson. Some parts of the Dodd-Frank Financial Reform
legislation are steps in the right direction. I would point
particularly to Title II, the resolution authority which is
being designed by the FDIC.
I have worked with them on this, and I have helped with
some of their outreach efforts. It is a tough technical
problem, particularly dealing with cross-border issues for the
global megabanks as currently structured, and there are a lot
of political issues that would need to be overcome if you were
actually to manage the orderly liquidation of one of these
colossal banks like a JPMorgan Chase or a Bank or America-
Citigroup, and so on.
I do think we need to support the FDIC in this effort. I
think it is very helpful to have Congress reaffirm the need for
an orderly resolution mechanism. Relying purely on bankruptcy
to handle these kinds of failures is not a good idea. That was
the big lesson from the collapse of Lehman in the fall of 2008.
I would also urge you to consider proposals that are now
resurfacing with regard to reintroducing some version of Glass-
Steagall. For example, Tom Hoenig, who as you know is now the
number two person at the FDIC, is absolutely I think on target
when he says large commercial banks of the kind that are
essential to the functioning of this economy should not be
allowed to have trading desks. They should not be allowed in
any way to engage in speculative, high-risk activities.
That part of banking should become boring. I think Mr.
Hoenig is exactly on target. I work in part with Sheila Bair on
some of these issues. I think she is exactly on target with
regard to having much more equity capital throughout the
financial system, particularly in these global megabanks.
So all of this suggests we should move further. I hope we
can move further on a bipartisan basis. I certainly hear plenty
of Republicans as well as Democrats saying they are very
worried about our existing financial structures. You should be
worried. We should all be worried, particularly given the
situation in Europe, the weakness of their big banks, and the
connections through these black box of derivatives in
particular to our very big banks that can absolutely damage our
economy again.
Making the banks small enough and simple enough to fail, so
that we can then use bankruptcy for them, is absolutely the
right goal to have as you consider future legislation on this
issue.
Vice Chairman Brady. All right. Thank you, Dr. Johnson.
Mr. Mulvaney.
Representative Mulvaney. Thank you, Mr. Chairman.
Mr. Johnson, just a couple of things. There are obviously a
lot of different topics we could go over today, but I want to
go over a couple of small pieces of your testimony. And
specifically you advocate for strengthening the revenue base of
the Federal Government, returning closer to the tax rates of
the late '90s. This is in conjunction with the writing you have
done regarding the expiration of the Bush-Obama tax cuts.
I think you are right, by the way, to call them the Bush-
Obama tax cuts. Not a lot of folks in this town do that, but
you are absolutely right in that they were approved by this
President in a Congress controlled by his Party at the end of
2010. So I applaud at least the candor on that front.
But the testimony you've got has a sentence that struck me,
which is that: ``We need to strengthen the revenue base of the
Federal Government'' and then--``returning closer to the tax
rates from the 1990s.''
Now it strikes me those two things are not exactly the same
things are they? The base is the size of the economy, or the
number of people who are paying into the system. And the rates
are what those people pay, or what you charge against that side
of the economy? Is that right? The base and the tax rate are
really not the same thing, are they?
Dr. Johnson. You are absolutely right. The base is the
taxable base, that part of the economy which you feel you can
tax. And the rates are what you are applying against that base.
Representative Mulvaney. And you put that together and that
is where you get your revenue. So let's talk about the base.
Because one of the things we have talked about in this
committee in the past is the size of the base. And you are
advocating for a return of the Bush-era, the Bush-Obama tax
cuts. Do you believe that will broaden the base?
Dr. Johnson. Well just increasing the rates in any tax
system doesn't address the base issue. We also propose to
eliminate or phase out a lot of so-called tax expenditures
which, as you know, are both on the individual tax side and on
the corporate tax side, are part of what narrows the base.
And when people talk about tax reform, they talk about
doing both. We are in favor of tax reform, but we would rather
have tax reform that raised revenue rather than being revenue
neutral or in the context of revenue cutting. So that is the
difference, pure and simple.
Representative Mulvaney. And that is something we all agree
on, in terms of ending the tax expenditures in an effort to
broaden the base. One of the things we hear regularly,
gentlemen, is that roughly half the folks do not pay the income
tax. And that as a result, they do not pay for the operation of
government. They may pay the payroll tax, which pays for their
specific benefits, most notably Social Security and Medicare,
but they do not actually pay for the running of the government.
So I will ask you, Dr. Johnson, a question I have asked a
couple of other people. Which is: Do you think that everybody
should help pay for defense?
Dr. Johnson. Absolutely, Congressman. And I believe that
everybody does. Now you are right, of course, that payroll tax
is notionally marked as going to Social Security and going to
Medicare. Those are of course very big government programs.
Twenty percent of government spending is on Social Security, 15
percent and rising is on Medicare. But people across the income
spectrum pay lots of other taxes at the state, local, and
federal level, including property tax and sales tax.
This all contributes to the funding of the government.
Representative Mulvaney. Agreed. But let's--because it's
come up in previous hearings, and you have not been party to
those so I understand that you want to focus on a broader
issue, but the issue we have talked about on this committee
before is specifically defense.
Which is, if I pay my local property taxes, I am paying for
schools. I'm paying for my local roads. If I pay my gasoline
tax, I'm paying for roads. If I pay my state sales tax, I'm
paying for everything that the state provides me. But defense
is somewhat unique, isn't it? Tell me how everybody is paying
for defense? Because it may be and I just don't see it.
Dr. Johnson. Well money is fungible, Congressman. And to
the extent you are contributing to government and you are
supporting all the activities of government across the
different levels of government--state, local, and federal--I
think anybody who is paying into that system, anybody who is
paying any kind of tax, anybody who is participating in the
modern taxed economy, is helping to support government.
So that we don't pay--none of us pay a particular tax
marked for defense, but even if we did it would be somewhat
meaningless. Money is coming in and money is going out of the
budget, and that is the overall balance which we need to take
care of.
Representative Mulvaney. Sure. And obviously I agree with
the concept that money is fungible, but I can assure you that
the money that we pay to the state is not fungible for the
money that the Federal Government uses to provide defense.
Would you agree with me on that?
Dr. Johnson. Well a lot of the Federal Government spending
is shared with, or passed down to state level. So I think that
the--while it's absolutely true that if the state decides to go
off and spend an extra marginal one dollar, the Federal
Government does not necessarily back that; a lot of funding, a
lot of projects are actually joint. It is a great thing about
the fiscal federal system that we've established and run for
200 years, and something the Europeans do not have and
desperately need to have, exactly this kind of balance between
the different levels of government and a shared funding and a
shared burden of funding across all citizens, all tax-paying
citizens.
I think the American system has much to commend it around
the world. Particularly, I commend it all the time to the
Europeans.
Representative Mulvaney. Got 'cha, and I don't mean to
belabor the point, but there's been other folks--you are the
first person to actually claim that everybody is paying for
defense by virtue of the fact that they're paying the payroll
tax, they're paying their property taxes, they're paying the
gasoline tax, and they're actually in effect paying for
defense. So I apologize for drawing that out. Maybe we can
visit that another time.
With the Chairman's indulgence? Can I continue for a few
minutes?
Vice Chairman Brady. Sure.
Representative Mulvaney. Thank you. You have got a
statement also in your testimony, Dr. Johnson, number four,
that says:
``The idea that the recent increase in public debt is due
primarily to 'runaway spending' since 2008 is completely at
odds with the historical record--although it is true that
spending was not under control in the period 2000-08 . . . .
The worsening deficits since 2008 have been primarily due to a
big drop in tax revenue and the sharp fall in GDP due to the
finance-induced recession.''
Let me deal with a very quick credibility issue. So I'm
hoping I don't get the answer that I think I just read, which
is: Are you saying that spending wasn't a problem in 2008 until
now? But it was a problem from 2000 to 2008? Not a driver of
our deficits, maybe a synonym for problem?
Dr. Johnson. Part of the problem from 2000 to 2008 was,
part of what happened, was two foreign wars. Obviously that is
spending. Medicare Part D. That is in addition to social
insurance. That is spending, no matter how you look at it.
The big hit since 2008 was the Recession. Again--well
probably I am quoting the Congressional Budget Office there,
and partly I'm quoting the IMF. The details are in the book
chapter to which I refer there. I would be happy to send that
to you. The point is, when you have an enormous recession
caused by any financial sector blowing itself on the scale we
experienced, that blows a big hole in the tax revenue.
Also, you get some additional spending from unemployment
insurance, which is a completely sensible social safety net you
have in the event, for examples, your banks blow themselves up
because they were reckless and took crazy risks.
So that is a consequence of the financial crisis. And the
fall in GDP, of course, means that even if you were--even if
you kept spending at the same level, it would look bigger
relative to the GDP, again because the banks have blown such a
big hole in your economy. So that is the specific sense in
which I mean it, Congressman.
Representative Mulvaney. And I understand. You go on later
in your testimony to--I think you quantify the Bush tax cuts'
impact on the deficit in 2010 as being roughly $270 billion.
You may not be aware that Mr. Van Hollen, the Ranking Member on
Budget, asked the CBO to quantify the effects of the Recession
on the 2010 deficit as well, and they placed it at roughly $370
billion, which gets us somewhere in the realm of $600 billion,
which was half of the deficit.
So can we at least agree that maybe half of the deficit is
driven by a spending problem and not necessarily by GDP or the
Bush tax cuts?
Dr. Johnson. I'm afraid not, Congressman. I'll have to look
at the details of what the CBO said--I haven't had a chance to
review that--but if you're saying the effect of the Recession,
a large part of the effect of ``the Recession'' is precisely
the loss of tax revenue.
In fact--and this is not specific to the United States.
Across all developed countries with any kind of modern,
sensibly functioning government, when you have a big recession
you lose revenues.
In fact, in many countries this is referred to as the
automatic stabilizers and regarded as not a bad thing; it's a
good thing. From a point of view of thinking about the tax
burden on the economy, it automatically falls when you go into
a recession; therefore, it helps to buffer the losses.
Representative Mulvaney. But now you're being Keynesian.
You said you wouldn't do that.
Dr. Johnson. Well I know that people feel strongly about
Keynesian, and I'm not particularly a Keynesian on much of this
analysis, I have to tell you, but the view that there is an
automatic stabilizer in the sense that you tax less in a recess
and tax more relatively speaking in a boom, that is actually a
reasonable notion.
The Keynesian issue is: Can you stimulate the economy? Can
you micro manage the economy, particularly using fiscal policy?
On that, I have deep reservations. Fiscal policy, as the
Chairman said at the beginning, is for the medium run. Fiscal
sustainability to support growth. That's the right approach to
fiscal policy.
Representative Mulvaney. Dr. Johnson, I respect your
position. I just look at the numbers, and I look at the growth
in spending, the top-line spending--and I recognize that a
recession will have an impact on the receipts of the government
and thus an impact on the deficits on the government, but if
you look at spending in nominal terms--I have not had a chance
to do the math and convert it--but you are talking about a
government that's grown on a nominal basis by 100 percent in
the last decade. In fact, it grew 20 percent in just the 2009
fiscal year by itself. The expenditures of the government in
2000 were $1.78 trillion, and they are going to be roughly $3.8
trillion this year. So more than 100 percent over the course of
the last 12 years.
So I hear what you're saying. And I cannot but agree that
part of the problem would be coming from the GDP, and certainly
if you lower taxes and bring in less money that may contribute
in a short term to the deficit. But to say it is not a spending
problem I think undermines the overall argument.
But let me get the last issue to everybody. Because the one
thing we have not heard about today is productivity. And I
think one of the lessons that we can learn from Europe is that
they have been fairly locked into low productivity rates for a
long time. They may be contributing to their structural
deficits and the issues they are dealing with. They are
probably not solving their productivity problem even if their
countries are making steps to solve their fiscal problem,
productivity is still not particularly healthy in Europe.
We had a little boost here during the early stages of the
2008 Recession. But in the long term, I do not think we are
seeing any dramatic increases in productivity. In fact, the
Chairman mentioned more folks leaving the workforce at 62,
which generally speaking would be a time of their lives when
they would be productive members of society; now they are
turning into retirement ages.
So tell me, gentlemen, am I right to be focusing on this,
number one? And then if I am, tell me. And I am specifically
looking at Dr. Johnson, now, tell me--and I will go last to
him--tell me how raising taxes is going to increase our
productivity?
Dr. Rogerson.
Dr. Rogerson. Well I will say for starters, I think you are
right on base to say that productivity growth is absolutely
essential to the long-term health of the economy. I think there
is widespread agreement that productivity growth lies behind
the sustained improvements in living standards. So absolutely
we need to be focused on policies that influence productivity
growth in thinking about what policies are good for
productivity growth.
Having said that, I certainly do not think that raising
taxes are good for productivity growth. I would----
Representative Mulvaney. Is that a gut feeling, Dr.
Rogerson? Can you back that up?
Dr. Rogerson. I know of no evidence to have supported that.
I mean, I will temper it on the other side that I do not think
that all taxes need be bad for productivity growth. I think
some taxes might be relatively neutral in terms of productivity
growth.
If you think that a major source of productivity growth is
the incentives to innovate, many tax policies may not be a
first-order importance in terms of the incentives for
innovation, for example.
But taxes on--progressive taxes on labor income, for
example, the more productive you become the higher tax rate you
pay, that obviously can provide a disincentive for people to
accumulate skills which would be a negative factor for
productivity.
So I think productivity is absolutely important. Taxes
certainly--some taxes I believe can have important negative
effects on productivity, but I would not go so far as to say
all taxes are negative for productivity.
Representative Mulvaney. Dr. Biggs.
Dr. Biggs. When I think about the EU, I mean it is not--
it's not that a French or a German worker is necessarily less
productive than an American workers for each hour that they
work. They are skilled people and they are good at what they
do. The issue is that they are simply not working the same
sorts of hours that American workers are doing. And the
question is: Why?
I think Professor Rogerson's research provides compelling
evidence that one reason why they work so many fewer hours is
the tax rates are a lot higher today than they had been in the
past. And that obviously does, it leads to issues in terms of
skills' accumulation.
Because if you know you are going to be working more hours
over the course of a year, or having a longer career, building
up human capital provides a larger payoff to you.
In addition, when you have individuals who are shut out of
the labor market for a long period, as you had in Europe for
quite some time, and unfortunately as increasingly we're having
here, their skills deteriorate. Their connection to the
workforce becomes more tenuous. And so even when they do get
back to work, that is when their productivity suffers, when
their output-per-hour actually will fall.
So I think there is a connection, and I think the fact that
Americans work 100 hours or so more a year than many Europeans,
I think that is not disconnected from tax rates. I'll say that.
Representative Mulvaney. And finally, Dr. Johnson.
Dr. Johnson. I have three responses, Congressman.
First of all, I am not proposing anything close to European
tax rates. No one has been a more outspoken critic of the
European fiscal system. And to your other interests, Mr. Brady,
the monetary system, than I have. I have written extensively
about this. It is a disaster.
And we don't want to go there, and I don't think we are
going to go there, and I don't think that is what we're talking
about.
Secondly, on labor market participation, Dr. Biggs has
already given you exactly the right answer. Which is: If people
start to fear that Social Security will not be there, then they
will retire earlier. That was his point about retiring at 62,
because you don't think the pension is going to be there.
People have to believe that the system is going to continue
in order for older Americans to remain working. We should be
increasing labor force participation, including through people
working the hours they work, including these older Americans
who have very valuable skills that we need to stay engaged with
the labor force.
The third answer is, to Professor Rogerson's point, we
should be taxing consumption more and income less. I have
testified, I think not before this committee but before a
number of other Congressional committees, on the advantages of
a Value Added Tax of some form.
That, to your point about productivity, is a very good way
to address your concerns. If you think we're taxing your income
too high, if we can agree on the role of government and how to
fund it, we should be funding it more with taxes on consumption
and less with taxes on income. It would address exactly your
concerns. But I understand there is bipartisan hesitancy to
move towards a VAT, despite the fact there are only two G-20
countries that don't have a VAT: Us, and Saudi Arabia. And
Saudi Arabia doesn't have a shortage of revenue.
Representative Mulvaney. Gentlemen, thank you very much.
And I especially appreciate the indulgence by my Chairman for
the extra time.
Vice Chairman Brady. Thank you, Mr. Mulvaney. I went over
on my time, as well.
I want to thank our witnesses today. This is a very
interesting conversation and the testimony really was very
insightful, and I appreciate that as well. I appreciate Senator
Bingaman and the Members, Mr. Mulvaney, who were able to
attend. But for those who were not, as a courtesy I would like
to leave the record open for five days for questions to be
submitted in writing. We will pass them on to our witnesses,
and I would ask you to respond in a timely manner.
With that, thank you all very much for being here. The
hearing is adjourned.
[Whereupon, at 3:47 p.m., Wednesday, May 16, 2012, the
hearing was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared Statement of Representative Kevin Brady, Vice Chairman,
Joint Economic Committee
Today the Joint Economic Committee is holding the second of two
hearings on how taxes affect America's economy. This hearing focuses on
the taxation of labor. The first hearing on April 17th focused on the
taxation of capital.
My goal, as Vice Chairman of this Committee, is to ensure that
America has the strongest economy in the world throughout the 21st
Century. To do that, we must get our monetary policy right, get our
fiscal policy right, get our regulatory policies right, and open new
markets to U.S. exports.
A sustainable fiscal policy requires more than just closing the
trillion dollar gap between federal spending and federal revenues. A
sustainable fiscal policy requires economic growth.
A growing economy improves our fiscal outlook by increasing federal
revenues and reducing federal spending relative to the size of our
economy.
Sadly, however, economic growth and job creation are lagging under
President Obama. To understand how poorly our economy is performing
compared with its potential, let's look at this chart and compare the
big government-oriented Obama recovery to the free market-oriented
Reagan recovery:
From its low point in February 2010 following the recent
recession, the Obama recovery produced private sector job growth of
4.0%. Over the comparable time-frame, the Reagan recovery far eclipsed
the Obama recovery with 10.1% private sector job growth.
If President Obama had the same growth rate of private
sector jobs as President Reagan enjoyed, we would have over 6\1/2\
million more jobs today--that is more than one job for every two
workers currently counted as unemployed.
From its peak in October 2009, the unemployment rate has
declined by a meager 1.9 percentage points under President Obama. Over
the comparable time-frame, the unemployment rate dropped by 3.4
percentage points under President Reagan.
Under President Obama, the average real GDP growth rate
has been 2.4% over the 11 quarters following the recession. Over the
comparable time-frame, President Reagan delivered an average real GDP
growth rate of 6.1%.
More than anything, hardworking American taxpayers need cohesive
monetary, fiscal, and regulatory policies that encourage business
investment--business investment in new buildings, equipment, and
software. Joint Economic Committee Republicans have shown that such
private sector business investment is the key to robust economic growth
and private sector job creation.
Leading economists believe that taxes affect the incentive to work,
save, and invest. Thus, federal tax policy not only determines how much
the federal government collects, but also how much the U.S. economy
grows and how many jobs are created.
Other economists seem to believe taxes don't really matter. In
their view, one tax increase to reduce the federal budget deficit is
just as good as another.
The purpose of this hearing is to examine the empirical evidence
offered by both sides of the debate.
In his written testimony, Dr. Rogerson presents evidence that taxes
on labor substantially reduce employment and economic output. When
these taxes are used to fund transfer payments and social services, the
adverse effects on jobs and economic growth are even greater.
Dr. Biggs presents evidence that these adverse effects depend in
large part on the specific tax and benefit rules of each entitlement
program. Older workers are especially sensitive to the marginal net tax
rate. That is the additional after-tax income received in exchange for
working and paying taxes an additional year.
For his part, Dr. Johnson presents evidence that our taxes are
lower than they have been at times in the past; and they are lower than
many other countries' taxes today.
The question we face today is whether tax policy really matters.
Can Congress allow the tax reductions of 2001 and 2003 to expire
without any adverse effects on jobs and economic growth? Would this be,
as many leading economists and my Republican colleagues have suggested,
``taxmageddon''? Or, as President Obama and many of my Democratic
colleagues contend, can Congress increase other federal taxes on the
businesses and the ``wealthy'' with economic impunity?
Should Congress instead focus on fundamental tax reform and
carefully consider which tax policies will provide the greatest boost
to long-term growth and job creation in the private sector?
Hopefully, today's hearing will help us answer these questions. I
look forward to the testimony of our distinguished witnesses.
Statement of Andrew G. Biggs, Ph.D., Resident Scholar, American
Enterprise Institute\*\
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\*\ The views expressed in this testimony are those of the author
alone and do not necessarily represent those of the American Enterprise
Institute.
---------------------------------------------------------------------------
Vice Chairman Brady and Members of the Committee: Thank you for the
opportunity to testify with regard to the effects of taxes and transfer
payments on labor supply and the employment.
While taxes are designed to raise revenue for the government, tax
policy can also have important effects on individuals' decisions to
work. The behavioral impact of tax policy has been studied by
economists for decades with an aim to minimizing the economic costs of
raising a given level of revenues. However, relatively little attention
has been given to how Social Security's taxes and benefits affect labor
supply. While the program's effects are not large for individuals in
their prime working years, Social Security tax and benefit rules
present significant work disincentives for individuals considering
delaying retirement. Altering these rules could increase labor supply
and improve retirement security at little cost to the federal budget.
Social Security is the largest single domestic spending program of
the federal government. Unlike most federal programs, it levies a
dedicated tax on earnings and pays retirement, survivors and disability
benefits in return. The 12.4 percent Social Security payroll tax on
earned income is the largest tax paid by most Americans, and thus it
has significant potential to affect their labor supply decisions. In
exchange for their payroll taxes, individuals can become entitled to
future benefit payments for themselves and eligible family members. The
effect of Social Security taxes on labor supply cannot be analyzed in
isolation from the benefits those taxes ``purchase.''
Social Security analysts think of these issues in terms of the
``net tax rate,'' which is equal to the statutory 12.4 percent payroll
tax rate net of the present value of any future benefits those taxes
purchase. The present value of benefits is a function of the time until
benefits will be paid, the expected duration of benefit receipt, the
riskless rate of interest at which individuals might invest, and any
risk premium individuals apply to Social Security benefits due to
solvency or political risk.
If the benefits an individual becomes entitled to are equal to the
taxes he pays, his net tax rate is zero. In such cases, the Social
Security program should have relatively little effect on an
individual's labor supply decisions. If an individual's net tax rate is
negative, which can be the case for lower-earning individuals, then
Social Security might encourage work. And if his net tax rate is
positive, then labor supply is discouraged.
According to Social Security's actuaries, a middle income two-
earner couple retiring in 2014 can expect to receive lifetime Social
Security benefits equal to around 78 percent of the taxes they pay.\1\
This implies that on a lifetime basis, around 78 percent of the Social
Security payroll tax (or 9.7 percentage points) can be viewed as a
``contribution'' which will be repaid at retirement or disability,
while the remaining 2.7 percentage points can be viewed as a ``pure
tax'' for which no benefits will be received.
---------------------------------------------------------------------------
\1\ This figure is based upon current law scheduled benefits.
Reform could alter these figures and, to close the program's financing
gap, must necessarily reduce the ratio of total benefits received to
taxes paid.
---------------------------------------------------------------------------
However, labor supply decisions are not generally made on a
lifetime basis. Rather, at any given point in time an individual may
decide whether and how much to participate in the labor force. Thus,
what matters in terms of Social Security's impact on labor supply is
what might be called the marginal net tax rate, that is, the benefits
an individual receives in return for working and paying taxes over a
given period of time, such as a year.
In general, the theory of optimal taxation states that taxes should
be highest in circumstances in which individuals are least sensitive to
the tax and lowest when individuals are most sensitive to tax rates.
Following this rule will tend to minimize the harmful effects of
taxation on work and the economy.
However, Social Security's treatment of older workers is precisely
the opposite of what economic theory recommends. Social Security pays
the lowest reward to work to older workers who are near to retirement.
These individuals, research indicates, are among the most sensitive to
tax rates, because they have the easiest option to leave the workforce
and retire.
Social Security's benefit formula is roughly actuarially fair for
individuals who choose to delay claiming benefits. For instance,
imagine a person who leaves the labor force at age 62. He can claim
retirement benefits at any age from 62 through 70. For each year he
delays claiming benefits, his eventual monthly benefit rises by around
7 percent. Over the course of an average lifetime, total benefits are
about the same if you claim at age 62, 70 or any age in between.
However, Social Security is not actuarially fair with regard to
individuals who delay claiming and remain in the workforce. Most near-
retirees who extend their work lives receive little or no additional
benefits for any extra taxes they pay. Thus, their net tax rate is very
close to the statutory rate of 12.4 percent and therefore discourages
labor supply at older ages.
There are three reasons for this. First, Social Security benefits
are based upon an individual's highest 35 years of earnings. An
additional year of work, particularly if it is part-time, is unlikely
to boost benefits. Second, most female retirees receive a spousal
benefit based upon their husbands' earnings. Any additional taxes they
pay are unlikely to lead to higher benefits. Third, once individuals
reach the full retirement age they are ineligible for Social Security
disability benefits, but must nevertheless continue to pay the 1.8
percent disability payroll tax.
In a 2009 research paper with David Weaver and Gayle Reznik of the
Social Security Administration, I found that for each dollar of
additional taxes a near-retiree pays into Social Security, he or she
receives only around 2.5 cents in extra lifetime benefits.\2\ Simply
put, Social Security provides almost no incentive to keep working.
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\2\ Reznik, Gayle, Weaver, David A. and Biggs, Andrew G. ``Social
Security and Marginal Returns to Work Near Retirement.'' Social
Security Administration. Issue Paper No. 2009-02. April 15, 2009.
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This would not be of major policy importance if near-retirees were
not so sensitive to tax rates. A middle-aged worker with a family to
support will likely continue working even in the presence of high
implicit tax rates, but once he or she reaches age 62 the option to
retire becomes more attractive. Moreover, most retirees receive pension
and Social Security benefits, which can increase the marginal income
tax rates they pay on earned income. Economic research finds that older
Americans are significantly more sensitive to after-tax rewards to work
than younger workers.
In a 2009 study that relied on differences in state income tax tax
rates, Lucie Schmidt of Williams College and Purvi Sevak of Hunter
College found that a 10 percent increase in after-tax earnings would
increase labor force participation by 7.5 percent among men and 11.4
percent among women.\3\ These estimated labor supply elasticities are 2
to 5 times higher than the Congressional Budget Office assumes for the
working-age population.\4\ In forthcoming research, John Laitner and
Dan Silverman of the University of Michigan find that eliminating the
payroll tax at age 59 would cause individuals to delay retirement by an
average of 1.1 years.\5\ And in a 2005 study, Eric French of the
Federal Reserve Bank of Chicago found that a 10 percent increase in
wages as of age 62 would dramatically increase work by seniors,
sufficient to boost overall labor supply by 1.1 percent.\6\
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\3\ Lucie Schmidt and Purvi Sevak. ``Taxes, Wages, and the Labor
Supply of Older Americans.'' Research on Aging, March 2009; vol. 31, 2:
pp. 207-232. http://roa.sagepub.com/content/31/2/207.abstract
\4\ Congressional Budget Office. ``Labor Supply and Taxes.''
January 1996.
\5\ Journal of Public Economics, forthcoming.
\6\ Eric French. ``The Effects of Health, Wealth, and Wages on
Labor Supply and Retirement Behavior.'' Review of Economic Studies,
April 2005, 72(2), 395-427.
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I have proposed reducing or even eliminating the Social Security
payroll tax for older workers as an incentive to remain in the
workforce. Doing so would lower Social Security tax revenues, but
increased labor supply from older workers would increase other
revenues, such as for federal income taxes, Medicare payroll taxes, or
state income taxes.
Using the Policy Simulation Group's Social Security models, I
estimate that eliminating the payroll tax for workers over age 62 would
reduce annual Social Security revenues by roughly 2.2 percent, or about
$16.2 billion in terms of 2012 tax collections. Using French's
parameters, eliminating the payroll tax at age 62 would increase
overall labor supply by around 1.4 percent.\7\ The offsetting increases
in non-Social Security revenues depend upon tax rates paid by older
workers. The average 62-year old working full time in 2010 earned
around $58,800,\8\ implying a federal income tax rate of about 15
percent. Adding the 2.9 percent Medicare payroll tax and a 4.4 percent
average state income tax rate,\9\ total non-Social Security revenues
would rise by around $18.3 billion, of which the federal government
would collect about $14.7 billion.
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\7\ Eliminating the payroll tax would raise wages by around 13.3
percent (106.2/93.8), times a labor supply elasticity of 0.1067 =
1.41%.
\8\ Source: American Community Survey.
\9\ See http://www.nber.org/taxsim/state-marginal/avrate.html
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These figures are approximate, but higher non-Social Security
revenues could at a minimum compensate for much of Social Security's
revenues lost to a payroll tax cut. As part of a Social Security reform
package, transfers of general tax revenue could compensate Social
Security for losses in payroll tax revenue, thereby making the payroll
tax cut neutral with regard to Social Security's solvency.
While eliminating the payroll tax for older workers would come at
little cost to the budget, the gains to individuals and the economy
could be substantial. Simply working one additional year would boost
average private pension income by almost 5 percent.\10\ This would
reduce poverty in old age and contribute to overall retirement income
security.
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\10\ Author's calculations using Policy Simulation Group models.
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Labor force participation among older Americans has ticked upward
as near-retirees seek to rebuild their 401(k)s. This demonstrates that,
even in a very challenging employment environment, highly motivated
individuals can often find positions. But overall, Americans today
still retire several years earlier than in prior decades, despite less
strenuous jobs and significantly longer life spans. The typical
American will spend one-third of his adult life in retirement, financed
by entitlement programs that cannot bear the strain. Social Security's
poor returns to older workers discourage delayed retirement, which
would strengthen the economy and is the single option available to many
individuals who reach retirement age with insufficient resources.
Policy options such as lowering the payroll tax rate on older workers
could increase labor supply, boost the economy and raise retirement
incomes.