program incentives in many countries. It then considers other issues that may promote or inhibit work at older ages.
Effect of Social Security Plan Provisions on the Incentive to Retire
Very strong evidence on the effect of pension plans on retirement is provided by cross-country comparisons of social security programs, which often have incentives like those inherent in employer-provided DB pension plans. The evidence presented is based on a coordinated set of studies conducted by analysts in each of the 12 countries in the International Social Security Project (e.g., Gruber and Wise, 1999 and 2007).
To assess the incentives for early retirement in each country’s program, a measure of these incentives called the “implicit social security tax” was developed. It summarizes the extent to which earnings from working one additional year (rather than retiring) are offset by the forgone pension benefit. To understand this measure, one might think of wage compensation from working an additional year as having two components. The first is earnings from wages, and the second is the increase in the expected present discounted value of future social security benefits. One might normally expect this difference to be positive, or at least not negative. In other words, if someone works one additional year and thereby receives one less year of benefits, it might be expected that when benefits begin one year later, they are increased sufficiently to offset the fact that they are received for one less year. For example, if the typical U.S. worker does not claim Social Security benefits at the earliest possible age (62) and instead works another year, benefits in subsequent years are increased by 6.7 percent to account for the fact that they will be paid for one less year.
In most of the countries covered by the International Social Security Project, however, benefit accrual is negative. This is due in large part to the fact that benefits are not increased sufficiently when benefit receipt is postponed, i.e., benefits are not actuarially fair. Therefore, a worker’s gain in extra wage earnings is partially, or even largely, offset by a loss in eventual social security benefits. The ratio of this loss to wage earnings (after tax) is called the social security implicit tax on earnings. In many countries this tax can amount to 80 percent or more at some ages.
To provide a simple summary of country-specific incentives for early retirement, the implicit tax rates on continued work are summed from age 55 or from the early retirement age—when a person initially is eligible for social security benefits—through age 69. This measure is called the “tax force to retire” (Gruber and Wise, 1999). The relationship between the tax force to retire and the proportion of men aged 55–65 not in the labor force is shown in Figure 5-11. There is a striking correspondence between the tax force to retire and men out of the labor force (unused labor capacity).