Repealing the retirement earnings test:

What's next for the labor market?

On April 7, 2000, President Clinton signed a bill eliminating the so-called retirement earnings test applied to retirees receiving Social Security benefits. A part of the Social Security program since its inception, the earnings test penalized retirees who worked by deducting a dollar for every three dollars above the established threshold of $17,000. The penalty was, in effect, a tax on working. Because of the nation's demographics and the labor shortage, Congress decided to change the law. Both the House and Senate passed the bill unanimously, a rare political feat.

The new law, which is retroactive to January 1, 2000, will affect approximately 900,000 beneficiaries. With the elimination of the earnings test, each beneficiary who decides to work will receive, on average, an additional $6,700 in benefits, according to the Social Security Administration.

Taking this new incentive into account, we asked the question: Just how many beneficiaries might be induced to work? In 1995, only 20.9% of all the employable persons within the age range of 65-69 were working or looking for work. The roaring economy and the tight labor market added roughly 2 points. In 1999, 22.2% of employable persons were participating in the labor force.

Using figures from the Social Security Administration and the Statistical Abstract of the U.S, the Beacon Hill Institute estimates that the new provision would raise wages by 34% for those who work. For every 10% increase in wages, the labor supply rises by 4.4%.(1)  In the current context, this means that the proportion of those aged 60-69 who work will rise from 22.2% to 25.5%.

 1 I. Hansson and C. Stuart. “The Effects of Taxes on Aggregate Labor: A Cross Country General Equilibrium Study,” Scandinavian Journal of Economics, 95: 311-326, 1993.

Methodology

According to the US Census, the annual median money income in 1997 dollars for people aged 65 and older was $17,768. Assume a 10% increase due to inflation and we arrive at $19,545. The Social Security Administration estimates that each beneficiary affected by the legislation will receive an average of $6,700 representing an increase of 34%. The economic literature suggests a labor supply elasticity of .44. Then if wages rise by 34%, the labor supply will rise by 0.44*34% = 15%. The labor supply was 22.2% of those aged 65-69; it is this figure that will now rise by 15%, to 25.5%.