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Chairman Johnson, Ranking Member Becerra, and other members of the Subcommittee, thank you for the opportunity to appear before you for this timely hearing on options for ensuring the solvency of Social Security. As the Subcommittee is well aware, the 2011 Social Security Trustees Report was released last month, and it projects that the combined Social Security trust funds will begin to be drawn down in 2023 and will be exhausted in 2036, one year earlier than projected in the 2010 Trustees Report. Increases in both the number and life expectancy of retirees will drive the projected cost from 13.35 percent of taxable payroll in 2011 to 17.56 percent of taxable payroll in 2085. The projected cost in 2085 will exceed projected income levels by 4.24 percent of taxable payroll. The impending insolvency of the Social Security system is not uncertain. According to the Trustees Report, there is a 95 percent probability that the trust funds will be exhausted between 2030 and 2049.

To establish Social Security as a sustainable, solvent program, changes are necessary. A wide range of reforms have been proposed in recent years, and many of those proposals include changes both to future benefits and to payroll taxes. One example is the reform proposal of President Obama's National Commission on Fiscal Responsibility and Reform, chaired by former Senator Alan Simpson and Erskine Bowles.

From a mechanical accounting perspective, a sustainable Social Security program could be achieved by either a reduction in the rate of growth of future benefits or tax increases. Tax increases can be considered solutions that enlarge the Social Security program to save it, while proposals that affect future benefits to create solvency can be considered solutions that reduce the size of the program in an orderly, predictable, and appropriate fashion. But the economic consequences of these two options are very different. They have different economic effects, particularly on labor supply, even if they appear similar in accounting terms. Proposals to address the shortfall in Social Security often fail to recognize these effects and instead offer a combination of changes, arguing that a solution involving both sides of the ledger is "balanced" and reflects the fair, bipartisan compromise achieved in the 1983 reforms. A number of other Social Security reform proposals have sought to establish long-run solvency through benefit changes alone.

This is a hearing about the tax options to solve the Social Security problem, so my testimony will focus on the economic consequences of tax changes--to workers and employers, the economy, and the Social Security program and beneficiaries. The taxes paid into the Social Security trust funds originate from two sources. First, the vast majority of trust fund income comes from a 6.2 percent employee payroll tax and a 6.2 percent employer payroll tax and the parallel 12.4 percent tax on self-employment earnings. Second, a portion of income taxes imposed on certain Social Security benefits are also directed to the Social Security program. The payroll tax is subject to a wage ceiling, currently $106,800 in 2011. Payroll taxes totaled $637.3 billion in 2010, and income taxes paid to the trust funds totaled $23.9 billion.