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The Labor Supply Effects of the Social Security Earnings Test

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Author Info
Leora Friedberg
Abstract

The Social Security earnings test reduces benefits at a 33-50% rate once earnings pass a threshold amount - among the highest marginal tax rates in the economy. Previous research dismissed the importance of the earnings test but failed to take advantage of three changes in the earnings test rules in order to identify its impact. Each change applied to some age groups and not others - which make them useful for identifying the effect of tax rules on the labor supply of working beneficiaries. Beneficiaries in the Current Population Survey satisfy the strongest prediction: many keep their earnings just below the exempt amount, and this bunching shifts with the earnings test rule changes. The rule changes are then incorporated into an econometric model of labor supply to identify income and substitution elasticities. The resulting elasticity estimates suggest considerable deadweight loss suffered by working beneficiaries. Simulations predict a substantial boost to labor supply from eliminating the earnings test, and at a minimal fiscal cost. However, a slight decrease in labor supply is predicted from the recently legislated increase in the exempt amount.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7200.

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Date of creation: Jun 1999
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Handle: RePEc:nbr:nberwo:7200

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Find related papers by JEL classification:
J14 - Labor and Demographic Economics - - Demographic Economics - - - Economics of the Elderly; Economics of the Handicapped
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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References listed on IDEAS
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  1. Mark E. Votruba, 2003. "Social Security and Retirees' Decision to Work," Working Papers 853, Princeton University, Department of Economics, Industrial Relations Section.. [Downloadable!]
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