Social Security, Earnings Tests, and Age at Retirement

Abstract

The effect of a Social Security system on the decision to retire is a matter of considerable controversy. Among the aspects of such systems causing debate have been the existence and effects of imperfect capital markets, the purported incentives embodied in "earnings tests, "the degree of actuarial fairness in such systems, and the degree to which incentives increase or decrease at certain critical ages (62 and 65 in the United States). The present article contains an analysis of the retirement decision that illuminates many of these issues and provides new insights into the effects of Social Security on retirement. Using a straightforward labor-leisure model and associated analytical diagrams, the article shows the labor-supply effect of actuarial unfairness in the benefit formula, the impact of an earnings test in causing workers to postpone retire ment (thus increasing lifetime labor supply), and the impact of imperfect capital markets on the timing of retirement.