The Effect of Pension Income on Elderly Earnings: Evidence from Social Security Authors: Alex Gelber, Adam Isen and Jae Song Discussant: Gopi Shah Goda SIEPR-Sloan Working Longer Conference November 2017

Legislative history Prior to 1972, Social Security benefits were increased for inflation on an ad hoc basis An automatic benefit increase provision was adopted in 1972 Inflation rate was 3.2% OASDI had a positive actuarial balance Projections of this provision assumed an average annual inflation rate of 2.75% and a wage growth of 5% By early 1973, it was clear that inflation would be higher than had been expected

Legislative history In 1974, the Trustees Report issued its annual report and revealed a “startling actuarial imbalance of 2.98% of taxable payroll,” implying that tax rates would have to be increased by 27 percent Senate Committee on Finance appointed a panel, which issued a report highlighting the role of demographics and the 1972 benefit formula in the actuarial deficit Panel found that the formula adopted in 1972 “responds irrationally to changes in the rate of inflation and can produce patterns of replacement ratios inconsistent with the generally understood purpose of the Social Security system” and stated that eliminating this response was essential to achieving financial soundness. The Social Security advisory council was tasked to address the “overindexing” occurring because initial benefit levels increased as a result of two separate indexing mechanisms

Legislative history Social Security Advisory council recommended removing one of the indexing mechanisms so that wages were indexed forward to the retirement year reflecting wage growth, and the percentages in the benefit formula would not change with the CPI By 1977, the program was facing severe short- range problems, and the 1977 Amendments were signed into law on December 20, 1977 Source: Legislative Background of the 1977 Social Security Amendments, James Kelley and Joseph Humphreys, https://www.ssa.gov/history/notchfile3.html

Transitional guarantee Compute benefits under the old and new system, where: the old system benefit table would no longer be indexed after 1978 wages earned at age 62 or older cannot be used in the old benefit formula Beneficiary receives the higher of the two Available to those reaching retirement age in the first five years of the new formula Did not apply to those born prior to 1917

The “Notch” Source: Social Security Administration Issues and Answers: The Notch, https://www.ssa.gov/history/pdf/notch.pdf

Income and substitution effects Because earnings after age 61 were not used for cohorts born in 1917-1921, discounted lifetime benefits fell by ~$6,000  income effects In addition, the net marginal returns to additional earnings after age 61 fell by 21 percent for the 1917 cohort relative to the 1916 cohort  substitution effects

Results Net effect is a ~$5,000 increase in discounted lifetime earnings  income effect dominates Using the DOB discontinuity as an instrument for benefit levels, authors find that an (unanticipated) $1 increase in benefits reduces mean discounted lifetime earnings by 61 cents  lower bound of income effect Using a difference-in-discontinuities framework, authors estimate an insignificant change in earnings from substitution effect (extensive and intensive margin) Much of these effects appear to be front-ended

Krueger and Pischke (1992) Examine the effect of the “notch” on LFP, self- reported retirement, number of weeks worked from CPS using aggregated data from 1976-1988 for 60-68 year olds Find that after controlling for age and year effects, no evidence that labor force participation changed with either the level of Social Security wealth nor with the growth of Social Security wealth expected from working between 62 and 65

Identification in Krueger-Pischke (KP) Exploit differences in birth cohort that have different levels of Social Security Wealth due to “notch” Assumption: variation in SSW and growth in SSW are due exclusively to differences among cohorts who are otherwise identical except for benefit notch

Identification in this paper (GIS) Exploits sharp discontinuous relationship between DOB and OASI benefits that occurs for DOBs on or after January 2, 1917 Assumption: Any changes in earnings occurring in the absence of the notch reform would have occurred smoothly across the January 2, 1917 threshold

Comparison of results KP: “…largest estimate of the SS wealth/LS elasticity that we find… would imply that the growth in SS benefits in the 1970s could explain less than 1/6 of the decline in male LFP observed in that time period.” GIS: “…we find that the increase in OASI benefit levels can account for 57.6 percent of the decrease in elderly participation from 1950 to 1985…” Reasons why they differ: KP are not looking at earnings LFP vs. positive earnings as measure of extensive margin Differences in the level of variation (daily vs. annual) Measurement error in cohort for KP (age reported in CPS, not DOB)

Questions/comments Ways to test spousal decisions? Compulsory schooling laws – could effects be even larger than estimated? Heterogeneity