A Dynamic Model of Retirement and Social Security Reform Expectations: A Solution to the New Early Retirement Puzzle

Abstract

The need for Social Security Reform in the next years is hardly a matter of debate. Therefore, the widespread believe among Americans that Social Security will not be able to pay benefits in the long run at the level that was anticipated, does not come as a surprise. The government acknowledges the situation, and predicts that substantial benefits cuts will be necessary, yet no legislation has been passed to tackle the problem. Researchers, however, have rarely modeled the uncertainty over Social Security reform and benefit levels, and how they affect claiming behavior and retirement. The purpose of this paper is to assess the extent to which these perceptions of future cuts might explain the puzzle of earlier take-up despite bigger penalties to doing so in the presence of increasing longevity. By introducing a small amount of uncertainty (based on selfreported responses to questions regarding expectations over future cuts) of a relatively small cut (compared with what the government reports as necessary to solve the crisis) in a dynamic life-cycle model of retirement, we are able to match the claiming behavior observed in the data, without relying on heterogeneous preferences. Our results support the hypothesis that expectations over future benefits are affecting current behavior. We find that a mis-specified dynamic retirement model would erroneously predict that an increase in the NRA would delay claiming behavior and increase labor supply at older ages. Once the appropriate earnings test incentives are modeled, and we account for the probability of reforms to the system, an increase in the NRA has little effect on claiming behavior, and it can even increase the proportion of individuals claiming before the NRA. Authors' Acknowledgements We are grateful to a number of employees of the Social Security Administration who have patiently answered our questions. Among those individuals we are especially thankful to Barbara Lingg, Christine Vance, and Joyce Manchester for their time, and for their insights into a number of the issues discussed in this paper. We are grateful to MRRC for the financial support through grant UM06-17. Benitez-Silva is also grateful for the financial supportfrom the Spanish Ministry of Science and Technology through project number SEJ2005-08783-C04-01, and to the Fundacion BBVA.

The social security earnings test and work incentives

“…One potential concern in our single-equation approach is the endogeneity of the claiming decision. In a companion paper, we estimate simultaneous hazard models of benefit claiming and labor force exit and find effects similar to those reported here (see Benítez-Silva & Heiland, 2006).…”

“…Their motivation is to insure that they cannot be made worse off by changes to Social Security. Benítez-Silva, Dwyer, Heiland, and Sanderson (2006) present a dynamic model similar to ours, but which accounts for Social Security reform expectations, and show that the uncertainty over future benefit levels can help explain the large proportion of Americans claiming benefits early.…”

Social Security, Benefit Claiming, and Labor Force Participation: A Quantitative General Equilibrium Approach

“…In particular, they assume that individuals have different time discount factors and parameters that determine the weight of leisure in the utility function that also change over the life cycle. Benitez-Sílva et al (2007) attempt to explain the pattern of Social Security claiming behavior which is concentrated at the earliest claim age of 62. They show that the rules on the benefit adjustment associated with early retirement and earnings test as well as the uncertainty about the future of Social Security system are the important factors behind the early taking behaviors.…”

Social Security Literacy and Retirement Well-Being

“…This benchmark model is closely related to the ones presented in Benítez-Silva and Heiland (2007), and Benítez-Silva et al (2009), and does a good job at matching some of the most elusive evidence regarding individual behavior at older ages. As mentioned before this model improves upon those mentioned by also modeling employment uncertainty and unemployment insurance, and does an excellent job at matching the evidence on the claiming behavior in the United States.…”