Labor Supply Responses to the Social Security Tax-Benefit Link

Jeffrey B. Liebman, Erzo F.P. Luttmer, David G. Seif

NBER Retirement Research Center Paper No. NB 06-12
Issued in December 2006

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 develop a methodology for estimating the incentive effects of the marginal Social Security benefits that accrue with additional earnings on three measures of labor supply: hours, labor earnings, and retirement. We show how three sources of discontinuities in the marginal Social Security benefit formula can be exploited to identify these incentive effects. We find that the retirement hazard rate starts to increase sharply when the current year's earnings crowd out a prior year's earnings in the Social Security benefit formula. This result is consistent with individuals responding to incentives implicit in the Social Security benefit formula, but further analysis is needed to determine whether the Social Security rules cause this result.

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