Comments on Rudolph G. Penner and Richard W. Johnson, “Health Care Costs, Taxes, and the Retirement Decision” Alan Gustman August 10, 2006

2 What does the paper do? Poses an interesting question. –With higher taxes and health costs in 2030, how will retirements change? Estimates extra health and tax costs in Assumes extra costs are met by delaying retirement and thereby increasing Social Security and 401k benefits. Calculates upper bound of delay in retirement as the additional time needed for increased benefits to match increased costs.

3 The authors adopt a simple model to frame their discussion. –In their model: Utility is a function of purchased health goods, other goods and leisure. Budget line with income from current earnings, investment income, pension and social security benefits financing health spending, other goods and leisure. –Their informal discussion asks how the shock of increased costs will affect outcomes. –While they draw some conclusions from apriori reasoning, they find many effects of increased health costs and taxes are ambiguous.

4 The authors are skeptical that people will forecast higher costs. Problems include: –Projections are too complex. –Badly informed about looming costs. So without other behavioral adjustments, the burden of higher costs will fall either on retirement or consumption in retirement.

5 When the authors calculate retirement increases from higher health and tax costs, they do not use the model. Projecting to 2030, the authors. –estimate increases in out of pocket health expenditures, Medicare and other health insurance costs. –assume taxes increase due to rising health costs and deficits. President Bush’s tax cuts expire. Real growth pushes taxpayers into higher brackets. More tax payers are subject to alternative minimum tax. Social security benefits subject to increased taxation. –allow incomes to grow. –calculate the change in retirement age for a 65 year old retiree so their additional social security benefits and 401k annuities cover the additional cost. –represent distributional effects. Compute values for low, medium and high earning couples and individuals retiring at 65 in 2030.

6 Projected maximum increases in work at age 65 in 2030 to cover higher costs. –Low income singles, 2.4 years. –Medium income singles, 2.5 years. –High income singles, 2.8 years. –Low income couples, 0.5 years. –Medium income couples, 2.0 years. –High income couples, 2.6 years. The authors conclude this is not a dramatic increase in retirement age, although it is substantial. –But our retirement models suggest reporting poor or bad health is equivalent to aging 3 or 4 years.

7 Why is main focus on age 65? Most retirement action is at ages earlier than 65. So to understand how health cost and tax increases affect retirements, one must model retirement flows before age 65.

8 Retirement Status by of Married Males by Age in the Health and Retirement Study

9 Those retiring in their fifties and early sixties may experience larger changes in health insurance costs. Retiree health benefits that are now disappearing are more valuable to those not yet eligible for Medicare.

10 Other considerations may inhibit delaying retirement in response to higher tax and health costs. –Social security availability at age 62. –Pension availability at ER age. –Own health status. –Rising disutility of work with age. –Employment policies of some firms.

11 Still other factors will encourage delayed retirement. For example: Employer policies in response to the retirement of the baby boomers. The trend to DC plans. Increased health and longevity.

12 Additional saving could mitigate the need for delayed retirement. How will saving change? –Many will not save. 40 percent of older males have a time preference rate greater than 10 percent, and a third over 15 percent. –But once made aware, many will save to offset future costs. 60 percent with low or moderate time preference might save to offset higher costs.

13 Some adverse consequences of their simple model Can’t model decisions to trade off between current and future periods. –Can’t model retirement in a one period model. –No saving. –In single period model, no behavior is forward looking. Can’t model complexities of budget constraint. Other factors are missed. –No model of uncertainty about future health needs, life expectancy. –No heterogeneity.

14 Without extending the model and estimating it empirically There are no estimates of the effects of increased health cost and tax increases on: –retirement –saving –use of health care or health insurance purchases –reversion to the social safety net by those who would otherwise have saved and been independent –consumption in retirement

15 Some effects of higher health costs and taxes on retirement that should be modeled. Increasing health costs and taxes reduce wealth, encouraging delayed retirement. –A retirement analysis should parse out the wealth effects from other factors shaping retirement. Taxes create substitution effects. Declining value of health insurance on the job reduces the marginal reward to work. More difficult to model – compensating wage differentials.

16 To address these and other questions requires specification and estimation of a model. Specify role of health insurance and taxes in the budget constraint. Estimate an appropriate multi-period behavioral model of retirement and saving. If necessary, modify the model for imperfect information and institutions that increase information. Project the opportunity set. Apply the model to estimate future changes in outcomes.

17 To model the future budget constraint requires allowing for new institutions. Changes in employer provided health insurance. –Will anything remain of retiree health insurance? Rise and growth of innovations. –E.g., retirement health accounts. –Expanded efforts to educate retirees about the need for additional saving to cover higher health costs in the future. Emergence of new insurance plans through government efforts, e.g., the new Massachusetts plan?

18 To generalize the analysis Focus on ages other than 65. Consider those who were born before or after Broaden the analysis beyond the impact in Estimate earnings paths rather than assume earnings for low, medium and high earners.

19 Conclusion This is an interesting first step, framing the elements of an important calculation. Many more steps remain to determine how taxes and health cost increases will affect retirement in 2030.