The title of this new paper from Jeffrey B. Liebman, Erzo F.P. Luttmer and David G. Seif, all of Harvard, may be a mouthful, but "Labor Supply Responses to Marginal Social Security Benefits: Evidence from Discontinuities" examines an interesting and important question: do participants in the Social Security program understand and respond to the incentives that the benefit formula presents to them? Here's the abstract: A key question for Social Security reform is whether workers currently perceive the link on the margin between the Social Security taxes they pay and the Social Security benefits they will receive. We estimate the effects of the marginal Social Security benefits that accrue with additional earnings on three measures of labor supply: retirement, hours, and labor earnings. We develop a new approach to identifying these incentive effects by exploiting five provisions in the Social Security benefit rules that generate discontinuities in marginal benefits or non-linearities in marginal benefits that converge to discontinuities as uncertainty about the future is resolved. We find clear evidence that individuals approaching retirement (age 52 and older) respond to the Social Security tax-benefit link on the extensive margin of their labor supply decisions: we estimate that a 10 percent increase in the net-of-tax share reduces the two-year retirement hazard by a statistically significant 2.1 percentage points from a base rate of 15 percent. The evidence with regards to labor supply responses on the intensive margin is more mixed: we estimate that the elasticity of hours with respect to the net-of-tax share is 0.41 and statistically significant, but we do not find a statistically significant earnings elasticity. The short story is that the authors conclude that we can reject the view that participants are completely unaware and unresponsive to the incentives presented by Social Security. As a result, gains from shifting to a more transparent means of Social Security benefit accumulation – namely, personal accounts – may be smaller than previously believed. A couple quick thoughts: First, marginal returns paid by Social Security to near-retirees are in general very low. Based on forthcoming work with David Weaver and Gayle Reznick of SSA, we found a median marginal return from an extra year of work of around -50%, which implies that continued work isn't a particularly good deal for most retirees. That said, there is a range of marginal returns, and from this range it should be possible to back out differences in labor force participation, as Liebman, Luttmer and Seif do. Second, while personal accounts potentially present clearer work incentives, in practice that's often not the case. Most personal accounts plans layer accounts over the current benefit formula (usually amended in some way to achieve solvency). As a result, participants would face all the incentive problems under current law Social Security, as well as any issues raised by the accounts. I suspect most workers would have a difficult time figuring out what their incentives were. As policy, clarifying and improving work incentives under Social Security should be a major priority, but it will take relatively large fixes to the benefit formula to get things right.
Monday, January 5, 2009
New paper: “Labor Supply Responses to Marginal Social Security Benefits: Evidence from Discontinuities”
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First, marginal returns paid by Social Security to near-retirees are in general very low. Based on forthcoming work with David Weaver and Gayle Reznick of SSA, we found a median marginal return from an extra year of work of around -50%, which implies that continued work isn't a particularly good deal for most retirees.
I did a similar analysis 22 years ago, back in 1986. I created a table for near retirees so that they could determine when it was best to retire. My father was the first one to use my table. In fact working past age 62 is negative since the entire SS-OASI benefit replacement rate is based on the change in US Avg Wages between age 60 and all previous working years. Because the average wage in the year you turn 60 is the key, any year past age 60 results in a replacement rate of less than 1 with the only benefit being indexed by COLA for each year you delay.
I was well aware back in the early 80's that those who were making close to the max base made decisions to retire based on SS benefits and the amount they would pay. Many chose to retire and setup S-corporations.
As policy, clarifying and improving work incentives under Social Security should be a major priority, but it will take relatively large fixes to the benefit formula to get things right. Relatively large fixed to get things right? The fix must balance both sides of the equation. On one side we have the $17 Trillion legacy debt. If you reduce payroll taxes, the ability to pay full benefits becomes impossible sooner.
The cost to fix Social Security is equal to the legacy tax. This legacy tax must be paid either in the form of increased taxes and/or reduced benefits. The equation must be balanced. We either let nature balance the equation or we take action now to change the benefit formula and taxes paid, forcing the cost to be shouldered by those who are benefiting the most now.
In general private accounts allow a worker to divert some percentage of their Social Security taxes to a private account. In exchange, the individual's Social Security benefit would be reduced by the value of the equivalent annuity of the diverted tax dollars plus interest at the Treasury rate. This is referred to as the "Offset" condition
The Social Security benefit formula would also change. Currently previous year’s wages are indexed by the change in the US Average Wage Growth, but now would be indexed by inflation. In addition the number of work years averaged would increase from 35 to 40. This would reduce current promised benefits by up to 30%.
All private accounts do is repackage the problem. It reduces the problem by legislating nearly a 40% benefit cut on those who retire in the future. They all fall far short of yielding the promised Social Security benefit under current law. 44% of your benefit comes from an 8.6% Social Security tax while 56% of your benefit comes from your diverted 2%. Theoretically diverting four percentage points could reduce your social security benefit to zero.
One must pay particular attention to the terms "payable benefits" and "promised/scheduled benefits." Payable benefits are generally equal to 60% to 70% of promised benefits. It is important to note what reference base is being used when evaluating private accounts. The only way payable benefits can equal promised benefits is for the combined assets of the trust fund and private accounts to total $20 Trillion by years end. The moral is "You cannot get something from nothing."
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