In the interests of self-promotion, I have a new paper in the AEI Tax Policy Outlook series that focuses on the Social Security earnings test. Here's the short story: Most seniors view the Social Security earnings test as a "tax" that reduces their Social Security benefits by fifty cents for each dollar they earn above a modest limit. In fact, the earnings test is not a tax at all: at a person's full retirement age, Social Security increases benefits to account for any lost to the earnings test in earlier years. Over the typical retiree's lifetime, total benefits are almost exactly the same. Most retirees are unaware of this because the Social Security Administration (SSA) and financial advisers fail to inform them of how the earnings test works. Retirees need better information--and policymakers should consider whether the earnings test makes sense at all. The basic story is that the earnings test has all the bad parts of a tax – distortion choices, limiting earnings, pushing people out of the workforce – without the good part, raising any revenue. People think of the earnings test as a tax because they're not told that at the full retirement age SSA adjusts their benefits to account for any months of benefits lost to the earnings test. At the least, we need to better inform the public; we should also think about whether the earnings test really makes sense going forward, given how hard it is to educate people about it. The full text is available here. UPDATE: For those interested in how the repeal of the earnings test for individuals over the full retirement age has played out, I should have also cited this paper by Joyce Manchester (CBO) and Jae Song (SSA).
Thursday, July 17, 2008
New paper: “The Social Security Earnings Test: The Tax That Wasn’t”
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2 comments:
Andrew working people don't calculate income on a lifetime basis. If you are among the majority of people who don't live to work but instead work to live the ratio that counts is take home to hours worked. The earnings test serves to reduce that ratio, each hour of extra work that puts you above the limit earns you that much less total compensation for that actual work month. Telling people that on actuarial average it will all work out doesn't get you out of bed and dragging yourself to your counter or cubicle, for most people work is not an daily intellectual challenge but instead another day tied to the strictures of a time clock and supervisors who can and do monitor both your break times and visits to the restroom.
Give me an office next to Brad DeLong in Evans Hall and privileges at UC Berkeley's Faculty Club bar and I'll work until I am ninety. On the other hand in my last job but one I spent 35+ hours a day standing on my feet assisting a never ending stream of customers. Not a problem when I was a kid flipping burgers, a little different when I started pushing 50.
Bruce,
There's a good amount of economic theory that indicates that people think about income over time. So, for instance, deductions from their income that go to a 401k affect their work effort differently than deductions that go to taxes, since they know they'll get their 401k deductions back in the future.
With the earnings test, you see many people working up to the earnings threshold but not beyond, because they believe that above the threshold they're looking at a 50% tax on their benefits, plus whatever other taxes they're paying. In fact, they'll get that money back -- plus interest -- once they reach the full retirement age. The fact that people aren't aware of this surely has a negative effect on how much they choose to work.
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