Labor supply among older individuals has been dropping for many decades, but it is difficult to determine precisely what role Social Security benefits played in that decline. The reason is that Social Security, as a national-level program, pays the same benefits using the same formula for people in every state. While labor supply declined over the same time period that Social Security payments increased, many other things happened to the country over that long time period.
In a new issue brief published by the Cato Institute, Daniel K. Fetter of Wellesley College and Lee M. Lockwood of Northwestern look at Old Age Assistance (OAA), the precursor to Social Security. What’s important is that OAA benefit levels and eligibility rules differed between states, so Fetter and Lockwood were able to better analyze the effects of these benefits on labor supply from individuals ages 65 and over.
Our results indicate that OAA significantly reduced labor force participation among older individuals. Up to age 65, the age pattern of labor force participation was similar in states with larger and smaller OAA programs. At age 65, however, a sharp divergence in labor force participation emerges. Our estimates imply that OAA can explain close to half of the large 1930–40 drop in labor force participation of men aged 65 to 74.
We also show that when we restrict the sample to non-U.S. citizens — who were eligible for OAA in some states but not others — we find similar reductions in labor force participation after age 65 in states in which noncitizens were eligible for OAA, but we can reject comparable reductions in states in which they were ineligible.
You can find the more technical version of the Fetter-Lockwood study at the National Bureau of Economic Research.
While we want protections for individuals who cannot delay retirement, we also want incentives so that those who can work longer will do so. One idea I’ve proposed is to eliminate the 12.4% Social Security payroll tax on workers aged 62 and above, to make it pay to stay in the workforce rather than retire.