Earnings Adjustment Frictions: Evidence from the Social Security Earnings Test

Alexander M. Gelber, Damon Jones, Daniel W. Sacks

NBER Working Paper No. 19491
Issued in October 2013
NBER Program(s):   AG   EFG   LS   ME   PE

We study frictions in adjusting earnings in response to changes in the Social Security Annual Earnings Test (AET), using a one percent sample of earnings histories from Social Security Administration microdata from 1983 to 1999. Individuals continue to "bunch" at the convex kink the AET creates even when they are no longer subject to the AET, demonstrating that adjustment frictions help drive behavior in a new and important context. We develop a novel framework for estimating an earnings elasticity and an adjustment cost using information on the amount of bunching at kinks before and after policy changes in earnings incentives around the kinks. We apply this method in settings in which individuals face changes in the AET benefit reduction rate, and we estimate in a baseline case that the earnings elasticity with respect to the implicit net-of-tax share is 0.35, and the fixed cost of adjustment is around $280. Our results demonstrate that the short-run impact of changes in the effective marginal tax rate can be substantially attenuated.

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This paper was revised on November 24, 2015

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Document Object Identifier (DOI): 10.3386/w19491

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