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Earnings Adjustment Frictions: Evidence from the Social Security Earnings Test

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

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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File URL: http://www.nber.org/papers/w19491.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19491.

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Date of creation: Oct 2013
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Handle: RePEc:nbr:nberwo:19491
Note: AG EFG LS ME PE
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  14. Henrik J. Kleven & Mazhar Waseem, 2013. "Using Notches to Uncover Optimization Frictions and Structural Elasticities: Theory and Evidence from Pakistan," The Quarterly Journal of Economics, Oxford University Press, vol. 128(2), pages 669-723.
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  17. Raj Chetty & John N. Friedman & Tore Olsen & Luigi Pistaferri, 2011. "Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records," The Quarterly Journal of Economics, Oxford University Press, vol. 126(2), pages 749-804.
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