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Estimating Earnings Adjustment Frictions: Method and Evidence from the Social Security Earnings Test

Author

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

Abstract

Recent literature has documented that individuals face frictions in adjusting their earnings with respect to policy, but this literature has not yet developed a method for estimating earnings adjustment costs. We introduce a method for estimating the cost of adjusting earnings, as well as the elasticity of earnings with respect to the incentive to earn. Our method uses information on the amount of bunching in the earnings distribution at convex budget set kinks before and after policy changes in the earnings incentives around the kinks: the larger is the adjustment cost, the smaller is the absolute change in bunching from before to after the policy change. We apply this method in the context of the convex kink created by the Social Security Annual Earnings Test (AET). Using a one percent sample of earnings histories from Social Security Administration micro-data, we show that individuals continue to bunch at the kink formerly created by the AET even when they are no longer subject to the AET, indicating that they must face adjustment frictions. 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, which can inform projections of the timing of earnings responses to tax and transfer policies.

Suggested Citation

  • Alexander M. Gelber & Damon Jones & Daniel W. Sacks, 2013. "Estimating Earnings Adjustment Frictions: Method and Evidence from the Social Security Earnings Test," NBER Working Papers 19491, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19491
    Note: AG EFG LS ME PE
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Philippe Aghion & Ufuk Akcigit & Matthieu Lequien & Stefanie Stantcheva, 2017. "Tax Simplicity and Heterogeneous Learning," NBER Working Papers 24049, National Bureau of Economic Research, Inc.
    2. Sören Blomquist & Whitney K. Newey, 2017. "The Bunching Estimator Cannot Identify the Taxable Income Elasticity," CESifo Working Paper Series 6736, CESifo Group Munich.
    3. Alpert, Abby & Powell, David, 2014. "Estimating Intensive and Extensive Tax Responsiveness: Do Older Workers Respond to Income Taxes?," Working Papers 987-1, RAND Corporation.
    4. Abby Alpert & David Powell, 2014. "Estimating Intensive and Extensive Tax Responsiveness Do Older Workers Respond to Income Taxes?," Working Papers WR-987-1, RAND Corporation.
    5. Weber, Andrea & Manoli, Dayanand, 2016. "The Effects of Increasing the Early Retirement Age on Employment of Older Workers," Annual Conference 2016 (Augsburg): Demographic Change 145549, Verein für Socialpolitik / German Economic Association.
    6. Daniel K. Fetter & Lee M. Lockwood, 2016. "Government Old-Age Support and Labor Supply: Evidence from the Old Age Assistance Program," NBER Working Papers 22132, National Bureau of Economic Research, Inc.
    7. Anthony A. DeFusco & Andrew Paciorek, 2017. "The Interest Rate Elasticity of Mortgage Demand: Evidence from Bunching at the Conforming Loan Limit," American Economic Journal: Economic Policy, American Economic Association, vol. 9(1), pages 210-240, February.
    8. repec:spr:jopoec:v:31:y:2018:i:1:d:10.1007_s00148-017-0664-x is not listed on IDEAS
    9. Alexander Gelber & Timothy J. Moore & Alexander Strand, 2017. "The Effect of Disability Insurance Payments on Beneficiaries' Earnings," American Economic Journal: Economic Policy, American Economic Association, vol. 9(3), pages 229-261, August.
    10. Jakob Egholt Søgaard, 2014. "Labor Supply and Optimization Frictions: Evidence from the Danish student labor market," EPRU Working Paper Series 2014-02, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    11. repec:eee:hapoch:v1_457 is not listed on IDEAS
    12. Philip Armour & Michael F. Lovenheim, 2016. "The Effect of Social Security Information on the Labor Supply and Savings of Older Americans," Working Papers wp361, University of Michigan, Michigan Retirement Research Center.
    13. Rauhanen, Timo & Harju, Jarkko & Matikka, Tuomas, 2016. "The effects of size-based regulation on small firms: evidence from VAT threshold," Working Papers 75, VATT Institute for Economic Research.
    14. Tazhitdinova, Alisa, 2015. "Adjust Me if I Can’t: The Effect of Firm Incentives on Labor Supply Responses to Taxes," MPRA Paper 81611, University Library of Munich, Germany, revised 2017.
    15. David Powell, 2015. "Do Payroll Taxes in the United States Create Bunching at Kink Points?," Working Papers wp327, University of Michigan, Michigan Retirement Research Center.
    16. Zhiyang Jia & Trine E. Vattø, 2016. "The path of labor supply adjustment. Sources of lagged responses to tax-benefit reforms," Discussion Papers 854, Statistics Norway, Research Department.

    More about this item

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • J14 - Labor and Demographic Economics - - Demographic Economics - - - Economics of the Elderly; Economics of the Handicapped; Non-Labor Market Discrimination
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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