Why the Social Security Earnings Penalty Should Be Repealed

Policy Backgrounders | Social Security

No. 152
Monday, February 28, 2000
by Bruce Bartlett

The Delayed Retirement Credit

The earnings test should be scrapped in its entirety. Either people have earned their benefits or they haven't, and singling out those who continue to work after retirement age is a violation of that principle. The only possible justification for keeping the earnings test is budgetary.16 Obviously, elimination of the test would lead to the payment of benefits that are now not paid, increasing federal outlays for Social Security. However, this cost is often grossly overestimated because estimates do not take into account the impact of the delayed retirement credit (DRC).

"Elderly workers in the 15 percent bracket can face a marginal tax rate as high as 80 percent."

The DRC raises benefits for retirees when they put off drawing Social Security benefits, even though they are eligible for them. Workers turning 65 this year will receive a 6 percent increase in their Social Security benefits for each year they delay drawing benefits. Thus, if their work history entitled them to $1,000 per month in benefits at age 65, but they did not begin drawing benefits until age 66, they would get $1,060 per month.17

The idea of the credit is to encourage workers to stay in the labor force and not retire the minute they become eligible for benefits. But many workers are under the mistaken belief that any benefits they fail to draw simply are lost. Hence, many workers are retiring too soon for their own good. A recent study from the National Bureau of Economic Research says that most workers would be better off by delaying their first Social Security benefit check by up to three years.18

"Participation of senior men in the labour force has dropped from 47 percent 50 years ago to less than 17 percent today."

In future years, the gain will increase. That is because the delayed retirement credit will rise to 8 percent in the year 2008 (for workers born in 1943).19 This means that someone waiting until age 70 before drawing benefits would get 40 percent more than if they started at age 65. (After age 70 there is no further increase in benefits and also no earnings test.20) At that point, the Social Security actuaries estimate that the lifetime benefits people receive from Social Security will be about the same in the aggregate regardless of whether they retire at age 65 or age 70.

The DRC is extremely important in calculating the long term budgetary impact of eliminating the earnings test. Those people who now lose benefits because of the earnings test receive higher future benefits. They also receive higher benefits because earnings past age 65 can cause their benefits to be recomputed. That is because Social Security uses a 35-year earnings history to calculate benefits. If post-65 annual earnings are greater than the lowest of these years, they can lead to higher benefits.

Because the DRC is supposed to cause lifetime benefits to be the same regardless of when people begin to draw benefits, the long term cost of eliminating the earnings test should in theory be zero. Higher benefits paid out in the short-run to people who would otherwise lose benefits because of the earnings test will be offset by lower future benefits because they will no longer claim the DRC.21

"There is no long-term cost to the government from eliminating the earnings test."

Another problem is that estimates of the net cost of eliminating the earnings test sometimes look only at increased payroll taxes that will result from expanded labor supply, as those now forced out of the labor market by the test remain in it or reenter.22 These estimates tend to overlook higher income tax revenues and reduced outlays for Medicare due to older workers having employer-provided health benefits. One study that did take all of the relevant factors into account found that after about eight years, the net increase in federal outlays is just $1 billion per year.23

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