Economist refutes prevailing view on Social Security tax (2/14/2008)

More elderly men than previously believed reduce the number of hours they work or even stop working to avoid losing Social Security benefits - a trend that has a "sizeable effect" on the U.S. labor force, according to new research from a Michigan State University economist.

The Social Security provision that reduces benefits for beneficiaries who work - called the retirement "earnings test" - will cover even more people in coming years due to rule changes already in progress, meaning the negative effects of the provision will grow, said Steven Haider, associate professor of economics.

Currently, Social Security beneficiaries between the ages of 62 and the full retirement age, currently 65 years and 4 months, have $1 in benefits withheld for every $2 they make in annual earnings over about $13,000. That amounts to a 50 percent tax. The full retirement age gradually will be increased to 67 by 2022, meaning more people will be subject to the tax.

"The retirement earnings test has been a disincentive for the elderly to work," Haider said. "It likely will become even more binding, because as the retirement age changes, more people are going to be facing this disincentive."

Haider's findings are published in the winter issue of the Journal of Human Resources, which is currently online at http://jhr.uwpress.org/current.dtl. Haider and co-researcher David Loughran of RAND Corp. studied the response of more than 350,000 Social Security beneficiaries over almost three decades.

While the study analyzed male workers, Haider said he has conducted parallel research that shows the trend holds true for female workers, too.

At least seven previous studies, from 1979 to 2003, argue that the earnings test has little meaningful effect on labor supply. But Haider's study - a comprehensive analysis of both longitudinal earnings data from the Social Security Administration and more commonly used survey data - found that three times as many workers quit working to avoid paying the tax than the previous studies reported.

The federal government eliminated the earnings test for workers ages 70-71 in 1983 and for workers between the full retirement age and age 69 in 2000. Most studies look at the response to one or both of those moves to draw their conclusions.

Haider predicts that pressure to eliminate the earnings test will grow once again, both because the labor force participation rate of the elderly has been increasing for the last decade and because the legislated changes in the full retirement age mean a broader age range of individuals will be subject to the tax. If the earnings test is eliminated, he said, it likely will affect the labor force more than the previous law changes because the younger Social Security beneficiaries - those between 62 and the full retirement age - will generally have more opportunities to remain in the labor force.

"My guess is that there will be pressure to remove the retirement earnings test again, and if we do that, it will have even larger effects than the previous eliminations," Haider said.

Note: This story has been adapted from a news release issued by Michigan State University

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