Social Security Induces Early Retirement Around the World
"In the early 1960s, the labor force participation rates of men 60 to 64 were above 70 percent in all but one of the countries and above 80 percent in several countries. By the mid-1990s, the rate had fallen to below 20 percent in Belgium, Italy, France, and the Netherlands and to about 35 percent in Germany and 40 percent in Spain. The U.S. decline from 82 percent to 53 percent was modest in comparison to the much more precipitous decline in these European countries."
In almost every industrialized country, the population is aging rapidly and individuals are living longer. These demographic trends have placed enormous pressure on the financial viability of the social security systems in these countries. This is compounded by another trend: in virtually every country, employees are leaving the labor force at younger and younger ages. That trend is most evident for men, but participation is also declining for older women, in spite of large increases in the labor force participation of younger women. In some countries, the labor force participation rates of 60-to-64 year old men have fallen by 75 percent over the past three decades, increasing substantially the proportion of retired persons to those in the labor force.
One explanation for the striking decline in labor force participation, emphasized by NBER Research Associates Jonathan Gruber and David Wise, is that social security provisions themselves provide enormous incentives to leave the labor force early, thus exacerbating the financial problems. They emphasize this aspect of social security plan provisions in Social Security Programs and Retirement Around the World (NBER Working Paper No. 6134), which summarizes evidence produced in an NBER project on social security provisions and retirement in eleven industrialized countries: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain, Sweden, the United Kingdom, and the United States.
In the early 1960s, the labor force participation rates of men 60 to 64 were above 70 percent in all but one of the countries and above 80 percent in several countries. By the mid-1990s, the rate had fallen to below 20 percent in Belgium, Italy, France, and the Netherlands and to about 35 percent in Germany and 40 percent in Spain. The U.S. decline from 82 percent to 53 percent was modest in comparison to the much more precipitous decline in these European countries. Japan stands out with the smallest decline of all the countries, from about 83 percent to 75 percent.
Gruber and Wise emphasize the foregone productive capacity of older employees who leave the workforce. One measure of foregone capacity is the proportion of persons out of the labor force, which for men age 55 to 65 ranges from 67 percent in Belgium to 22 percent in Japan. It is 37 percent in the United States.
Two features of social security plans have an important effect on labor force participation incentives: The first is the age at which benefits become available. The collective evidence for all countries combined shows that statutory social security eligibility ages contribute importantly to early departure from the labor force. In addition, unemployment and disability programs serve as early retirement programs in many countries. Very few persons retire before benefits are available.
The second feature is the change in the present value of future benefits if a persons continues to work, once benefits are available. This is called the benefit accrual. If the accrual is positive, it adds to total compensation from working an additional year; if the accrual is negative, it reduces total compensation. The ratio of the accrual to wage earnings is an implicit tax on earnings if the accrual is negative and an implicit subsidy to earnings if the accrual is positive. A negative accrual discourages continuation in the labor force; a positive accrual encourages continued labor force participation. As it turns out, the pension accrual is typically negative at older ages: continuation in the labor force implies a reduction in the present discounted value of pension benefits. That is, in most countries, because of insufficient actuarial adjustment for fewer years of pension receipt, combined with generous earnings replacement rates for retirees and high social security payroll taxes for workers, there is an implicit tax on work and an incentive to leave the labor force. The magnitude of the accrual, and the corresponding tax, differ greatly from country to country.
High implicit tax rates are common in European countries, with tax rates over 50 percent in many instances and in one case as high as 141 percent. Gruber and Wise find that the relationship between the implicit social security tax on work is strongly related to the labor force participation of older persons. A simple measure of the tax incentive for early retirement is the sum of the implied tax rates on continued work beginning at the early retirement age running through age 69, which the authors call the "tax force" to retire. The measure ranges from less than 2 in Japan to over 9 in Italy. (A measure of 10, for example, would imply a 100 percent tax rate on all earnings beginning at age 60.)
The relationship between this "tax force to retire" and unused labor force capacity (between ages 55 and 65) is shown in the figure. There is a strong correspondence between the tax force to retire and unused labor capacity, and the relationship is not very sensitive to alternative age ranges for measuring either the tax force or unused capacity.
Putting the evidence together, it is clear that there is a strong correspondence between the age at which benefits are available and departure from the labor force. The authors conclude that social security program provisions have indeed contributed to the decline in the labor force participation of older persons, reducing the potential productive capacity of the labor force. And, if the trend to early retirement is to be reversed, as will almost surely be dictated by demographic trends, changing the provisions of social security programs that induce early retirement will play a key role.
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