A Theory of Labor Supply Late in the Life Cycle: Social Security and Disability Insurance

This paper studies the role of social security and tax and transfer programs for understanding cross-country differences in labor supply late in the life cycle. First, we use the Survey of Health, Ageing, and Retirement in Europe (SHARE) as well as the U.S. Health and Retirement Study (HRS) to document consistently the facts on labor supply late in the life cycle (over the age of 50). Second, we build a life-cycle, heterogeneous-agent model which incorporates important determinants of labor supply late in the life cycle. In particular, we model cross country differences in (i) the pay-as-you-go social security system - the benefit formula, accrual profile, early and normal retirement rules; (ii) income taxation; and (iii) the disability insurance rules. We use the model to assess how these institutions affect labor supply late in the life cycle as well as their relative importance in accounting for differences in labor supply among the European countries and between the United States and Europe. Third, we use our quantitative theory to conduct policy experiments that highlight the interaction between the various social programs in affecting labor supply decisions. Preliminary results indicate that the theory accounts well for the cross-country variation in labor supply documented in the data and that both features - social security and disability insurance - quantitatively play an important role.