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The Social Security Earnings Test Revisited: Information, Distortions, and Costs

The labor supply and benet claiming incentives provided by the early retirement rules of the Social Security Old Age benets program are of growing importance as the Normal Retirement Age (NRA) increases to 67, the labor force participation of older Americans rises, and a variety of reforms to the Social Security system are considered. Any reform needs to take into account the effects and rationale of the Social Security Earnings Test and the Actuarial Adjustment Factor, which are widely misunderstood due to the relatively little attention paid by policy makers and researchers to the fact that Americans are willing to work while receiving benets. We describe these incentives, and emphasize that individuals who claim benets before the NRA but continue to work, or return to the labor force, can reduce the early retirement penalty by suspending the collection of monthly benets if they earn above the Earnings Test limit. We then argue that the Earnings Test can be distortionary and is costly to administer, and that these characteristics are inated by the lack of information given to older Americans regarding the consequences of working while receiving retirement benets. We discuss reform scenarios including the removal of the Earnings Test. We conclude that removing the Earnings Test, while giving individuals the option to suspend benets to increase the rate of benets after the NRA, is likely to be a welfare improving policy option from both the administrative and the individual perspective, unless the Social Security Administration is willing to invest more in informing the public about the fairly complex trade-offs linked to the decision of working while receiving benets.