More on behavioral economics and social security

Peter Orszag responds to yesterday’s post about the relevance of penalties on wage earnings before reaching full employment age – also known as the retirement earnings test.

It is true that if people don’t understand how the retirement earnings test (RET) works, knowing that it no longer applies starting at the full benefit age could cause some people to claim at that age. (Those who do understand the RET know that the recalculation that occurs when a beneficiary subject to the RET reaches the full benefit age compensates them for the benefits offset while they were still working – again making the benefit actuarially fair).

Whatever is or is not understood about the operations of the RET, the response to it is not large enough to drive the response that we see at the full benefit age. In a recent CBO working paper, Jae Song and Joyce Manchester found that the elimination of the RET in 2000 for people at the full benefit age through age 69 led to an increase of about 5 percentage points for men and about 2 percentage points for women in claiming at age 65 (the full benefit age) in 2000-2002. Hence the RET cannot explain the full peak of 12-14 percent moving out as the full benefit age rises.

Song and Manchester’s paper is here.

Alan Gustman and Thomas Steinmeier of Dartmouth and Texas Tech make a similar point about how Econs should respond to the retirement earnings test. Humans, we know, delay collecting Social Security until full-benefit age when there are no penalties on wages earned.

For persons between the early entitlement and full entitlement age, the earnings test is or is better than actuarially fair in that later earnings are increased so as to more than compensate for lost benefits from earnings over the annual exempt amount. Hypothetically, the earnings test should not affect retirement behavior.

In other words, Econs should start taking collecting early, try to earn enough money to eliminate as much of the benefits as possible, and then reap higher repayments later. At the very least, Econs should be unaffected by the test. But Humans’ high discount rates for comsumption prevent them from ignoring the earnings test.

Policymakers want to encourage people to work so that their dependency on Social Security decreases. However, together these papers indicate that one of the surest ways to increase employment is to eliminate penalities on wages at any age. Abolishing this kind of earnings test would tighten the government’s short-term cash flow, though with some possible longer term savings. This cash crunch is another reason why pushing back the full-benefit age – and thus keeping people working longer – is a more politically attractive alternative.

One Response to “More on behavioral economics and social security”

  1. Anittah Patrick Says:

    Yo, I need a picture. Can we get some colored bar graphs and an arrow up in this bidness? So many words to read 😉

    No rush; I’ve got another three decades before I’m retiring. Take your time.

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