Intensive and Extensive Margin Labor Supply Responses to Kinks in Disability Insurance Programs

Abstract

While kinks are prevalent in tax and transfer systems, the fiscal revenue and behavioral responses are not fully understood. In disability insurance (DI) programs, for instance, kinks help balance the moral hazard effects from the induced entry with the provision of work incentives for recipients who regain their ability to work. Using quasi-random variation in kink points in the benefit schedule for Norwegian DI recipients, I identify intensive and extensive margin earnings responses to the implicit tax on earnings as DI benefits are phased out above the kink. To identify the intensive margin responses, I implement a non-parametric bunching design that does not require functional form assumptions or deciding an excluded region around the kink. Responses correspond to an earnings elasticity with respect to the implicit net-of-tax rate of about 0.18. Using a regression discontinuity design, I further show that the kink in the benefit schedule induces significant responses at the extensive margin. I use the estimated earnings responses to evaluate how the benefit offset affects program costs, and find that relaxing the benefit offset reduces public expenditures only if program entry is very inelastic. My findings speak to recent policy-proposals aiming to improve work incentives of DI recipients.