Academic journal article Economic Inquiry

Policy Variation, Labor Supply Elasticities, and a Structural Model of Retirement

Academic journal article Economic Inquiry

Policy Variation, Labor Supply Elasticities, and a Structural Model of Retirement

Article excerpt

I. INTRODUCTION

In countries around the world, there is increasing pressure for social security reform (Organisation for Economic Co-operation and Development 2007). Designing effective social security reform requires understanding how changes in retirement benefits affect individuals' retirement decisions. In this paper, we exploit policy variation in individuals' retirement benefits to identify and estimate the income and price elasticities in individuals' retirement decisions. We then demonstrate what these elasticities imply for standard economic models of retirement decisions and for labor supply responses to potential social security reforms. (1)

Retirement benefits are traditionally thought to affect individuals' behavior through two channels: an income effect and a price effect (e.g., Boskin 1977). The income effect refers to changes in behavior due to changes in lifetime income. The price effect (or implicit tax on earnings) refers to changes in behavior due to changes in marginal incentives for continued work. The magnitudes of these effects are relevant for understanding how potential social security reforms are likely to affect the individuals' retirement decisions and welfare.

The analysis has two overall objectives. The first objective is to identify and estimate these income and price elasticities. We use administrative data from the Austrian Social Security Database and exploit variation from multiple pension reforms in Austria to identify and estimate these elasticities. The second objective is to demonstrate how these income and price elasticities can be used to estimate a structural model of retirement decisions.

The empirical analysis is therefore presented in two parts. The first part focuses on the identification of the income and price elasticities based on policy variation from five pension reforms in Austria between 1984 and 2003. Using administrative, social security records data on over 250,000 private sector employees in Austria, we define the income and price measures using social security wealth (SSW, the present discounted value of pension benefits) and the one-year accrual (the expected percentage change in SSW from delaying retirement by one year). The pension reforms create several independent changes in these measures thereby allowing for separate identification of the respective elasticities, which we estimate using a proportional hazards specification. We follow commonly used terminology and refer to the proportional hazards results as reduced-form elasticities. However, this proportional hazards specification is entirely independent from our dynamic model of retirement decisions and hence it is free of any distributional or functional form assumptions of that economic model.

We estimate that a 1% increase in SSW holding the accrual constant (i.e., an increase in SSW at all ages) increases the hazard rate at a given age by 0.44%. At the same time, we estimate that a 1% increase in the accrual holding SSW constant (i.e., an increase in next period's SSW holding current SSW constant) decreases the hazard rate at a given age by 2.90 %. Our estimates point to a much larger role for price effects than has previously been found in the literature. The studies by Gruber and Wise (2004) and Coile and Gruber (2007) provide the most directly comparable labor supply estimates (although their incentive [price] measures are parameterized differently) and they tend to find small and insignificant price effects, whereas we find large and significant accrual elasticities, both in absolute terms and relative to the estimated income elasticity. An important difference between their study and ours is that they rely on observational variation whereas we exploit policy variation from multiple pension reforms that independently vary the income and price measures. Interestingly, Friedberg (2000),who exploits multiple changes to the Social Security earnings test also finds a large role for price effects in determining hours worked among retirees in the United States. …

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