NB20-09: Misperceptions of the Social Security Earnings Test and the Actuarial Adjustment: Implications for Labor Force Participation and Earnings

The Old Age and Survivors Insurance (OASI) Annual Earnings Test (AET) reduces current OASI benefits by one dollar for each additional two dollars that OASI claimants under Normal Retirement Age (NRA) earn above the exempt amount. Previous research has shown that the AET reduces employment and earnings substantially among affected OASI beneficiaries (Burtless & Moffitt, 1985; Friedberg, 1998; Friedberg, 2000; Gelber et al., forthcoming; Gelber et al., 2018a, 2018b). However, when current benefits are reduced due to the Earnings Test, the actuarial adjustment raises benefits once a claimant reaches NRA. This raises the puzzle – unsolved in the existing literature – of why many individuals’ labor force participation and earnings react so strongly to a policy that imposes little long-term average financial burden on beneficiaries. This paper aims to provide an explanation for this puzzle.
Using Social Security Administration (SSA) data, we will show that the pattern of earnings for those who are near the AET exempt amount is consistent with their misunderstanding the policy: specifically, individuals act as if they believe the AET applies to all earnings (not just earnings above the exempt amount), and they ignore the actuarial adjustment. This has implications both for understanding the actuarial adjustment and the inequities it imposes across beneficiaries, as well as for long-term labor force participation as the population subject to the AET expands over time due to the rising NRA.
Our project will result in a research manuscript. We will pursue the following plan:
• Literature Review: we will draw on studies from the literature to inform the context for the paper.
• Theoretical predictions: we will derive a model with testable predictions of our hypotheses.
• Analysis: we will apply our methods to test for misperceptions.