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Changes in spending and labor supply in response to a Social Security benefit cut: Evidence from stated choice data

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Highlights

  • We investigate changes in labor supply and spending in response to a hypothetical Social Security reform scenario.

  • We use stated choice data to identify what individuals would do in response to a 30 percent benefit cut.

  • The majority of our respondents would adjust their behavior under the hypothetical scenario.

  • Adjustments include reductions in spending before and after retirement and delayed Social Security benefit claiming.

  • Working longer would compensate partially for the loss in benefits, yet there remains a sizeable financial loss.

Abstract

We investigate how individuals in the U.S. expect to adjust their labor force participation and savings if Social Security benefits were cut by 30 percent. Respondents were asked directly what they would do under this scenario. Using the resulting stated choice data we find that respondents would on average reduce spending by 18.2 percent before retirement and 20.4 percent after retirement. About 34.1% of respondents state they would definitely work longer and they would postpone claiming Social Security by 1.1 years. We investigate how working longer and claiming Social Security later would compensate partially for the loss in benefits among the individuals who are currently working, under the assumption that individuals retire and claim at the same time. Individuals would increase their Social Security benefits from the post-reform level due to additional earnings entering the benefit calculation and a smaller early claiming penalty (or higher delayed claiming credit). As a result, the Social Security benefit people would receive would drop on average by 21 rather than 30 percent. Still, the net financial loss, even after accounting for additional earnings, is sizeable for individuals in the lowest wealth tertile.

Introduction

The U.S. Social Security trust fund (OASI) is predicted to be depleted by 2035 (Board of Trustees, 2016). Although there are several viable reform proposals to restore the Social Security system’s long-term solvency, one important element that is critical to the success of any reform remains unknown: How will individuals respond, for example, to a cut in their Social Security benefits? Will individuals work longer or save more or both, and how much will their response make up for the cut in benefits? How would whatever individuals do to adjust be split across spending less and working longer?

It is important to understand how workers might respond to a benefit cut for at least two reasons. First, to evaluate the impact of such a benefit cut on the well-being of individuals (i.e., whether responses in behavior will be adequate to buffer the shortfalls in benefits and whether this would be the case across all groups of workers). Second, the response in individuals’ behavior determines the size of benefit cuts required for ensuring the solvency of the Social Security program in the long-run. If all workers decided to work longer to make up for the shortfall in benefits, then Social Security revenues would increase more than if workers decided to make up for the shortfalls by reducing spending but otherwise sticking with their retirement (and likely their Social Security claiming) plans in the absence of reform. For some workers, additional Social Security contributions would only result in a minor increase in their annual Social Security benefits, whereas for others the increase in benefits would be larger, depending on the worker’s earnings history.

Despite the relevance from a policy perspective of understanding individuals’ behavior in such circumstances, relatively little is known about how people would adjust their behavior in case of a reform that would decrease their Social Security benefits. Workers have two main ways to respond: they can work longer and/or save more. In the absence of additional constraints, economic theory predicts that individuals should adjust both their saving behavior and the length of their working life (Organisation for Economic Co-operation and Development (OECD), 2006, Martin and Whitehouse, 2008, Gruber and Wise, 2009, Sass et al., 2010, French and Jones, 2012). However, it has been difficult to show empirically how important each one of these dimensions is and how these two behaviors interact. Most studies focus on only one dimension of adjustment, either on the response to savings or on the response to labor force participation, but rarely on both.

Broadly speaking, there are three types of empirical studies on this topic: within-country studies, cross-country studies, and those adopting a structural approach. An important challenge for within-country studies is that there tends to be limited exogenous variation in Social Security rules that could be exploited. Examples of such studies, all focusing on labor supply, include Krueger and Pischke (1992) who investigate the effect of the 1977 amendment to the Social Security Act that sharply reduced benefits for some cohorts, Friedberg, 2000, Gruber and Orszag, 2003 who use changes in Social Security rules to investigate the effect of the Social Security earnings test, or Mastrobuoni (2009) who investigates the impact of the increase in the normal retirement age. While those evaluate the impact of enacted reforms, for obvious reasons, policymakers are interested in empirical studies that would inform the design of a reform before enacting it. They therefore have to contend with evidence from other countries that have implemented reforms. Examples of studies that present evidence of this sort are Attanasio and Rohwedder (2003) for the United Kingdom, Attanasio and Brugiavini for Italy (2003), and Aguila (2011) for Mexico. Yet, differences in pre-reform institutional settings and preferences may limit what US policy makers can learn from what has happened in other countries.

Cross-country studies rely on variation in institutions, in particular retirement ages, and in pension formulas as exogenous variation to identify the effects of interest. Gruber and Wise, 1999, Gruber and Wise, 2004 adopt this approach to study the impact on labor force participation while Samwick (2000) studies how the characteristics of social security systems influence savings. Hurd et al. (2012) use institutional variation in public pension schemes across countries to study variation in wealth accumulation.

Beyond within-country and cross-country studies, another way to assess individuals’ responses to Social Security reform is to estimate a structural model on data of observed choices and conduct policy simulations. Examples of such policies include the change in the normal or early retirement age, benefits reduction, increase in payroll tax or health insurance provision (e.g., Blau and Gilleskie, 2006, Gustman and Steinmeier, 2007, Van der Klaauw and Kenneth, 2008, Laitner John and Dan Silverman, 2012). While very powerful to simulate the behavioral impact of policies, the challenges of such structural models include computational complexities, taking into account institutional rules, typically unobserved (while complex) choice sets, and unobserved sources of uncertainty faced by decision-makers (e.g., Aguirregabiria and Mira, 2010). While the latter type of studies only take into consideration partial equilibrium effects, there are also a few studies looking at the impact of Social Security reforms within a general equilibrium framework (e.g., İmrohoroğlu and Kitao, 2009, İmrohoroğlu and Kitao, 2012).

In this paper, we complement existing studies by adopting a different approach. We ask respondents directly what they will do in the case of a cut of 30 percent of their Social Security benefits: whether they would work longer, claim Social Security later, reduce spending before retirement, and/or reduce spending after retirement. (Answer categories were “definitely yes,” “maybe,” and “definitely not.”) For each of these options, we follow up with questions to assess the size of the response. The advantage of this approach is that it allows us to investigate, without assumptions on individuals’ decision-making process or their knowledge of the Social Security system, the behavioral response to a reform currently considered before its enactment. Responses are those reported by individuals who could be affected by this reform. Using respondents’ stated choice, rather than actual choice, is becoming common in many fields (Louviere et al., 2000). Comparisons of revealed and stated preference data show that both data sets produced comparable utility parameters (e.g., Adamowicz et al., 1994, Ben-Akiva and Morikawa, 1990, Hensher and Bradley, 1993). Stated intention also relates strongly to subsequent actual choice (e.g., Haider et al., 2007, Delavande and Manski, 2010). However, stated preferences data are not without caveats and may be susceptible to biases. In particular, the context and format of the hypothetical setting have been found to affect the response, and choice model estimation results may therefore be sensitive to the elicitation format (Ben-Akiva et al., 1994).

The credibility of our results relies on individuals being able to predict how they would react to the hypothetical scenario. Whether stated preferences or stated choice questions will be successful in eliciting responses that are as close as possible to individuals’ actual behavior depends critically on how salient the event is for respondents and on whether they have already considered the scenario as a real possibility (McFadden, 1998). Several arguments suggest that the scenario we consider was salient and realistic, especially at the time of the survey in 2007. The need for Social Security reform to restore the solvency of the program has been well advertised in the media and by political leaders for a number of years.1 Time and time again, the message has been repeated that under current law, full benefits will only be payable until sometime in the 2030s; projections vary somewhat from year-to-year. After that, only about 75 percent of benefits will be payable given the current structure of the system. Importantly, workers’ Social Security statements that were mailed out every year until 2011 included this same message in bold face, and there is evidence that individuals consult their Social Security statement (Mastrobuoni, 2011). Moreover, in our sample, respondents believe on average that there is a 61 percent chance that Congress will change Social Security sometime in the next 10 years so that it becomes less generous than it is currently.2 We focus on a 30 percent cut because this was a plausible number discussed at the time of our survey. For example, in 2006, the Social Security Board of Trustees (2006) suggested either a payroll tax increase or a cut in Social Security benefits by 26 percent in 2040 (the estimated point of trust fund exhaustion at the time), with reductions reaching 30 percent in 2080. Finally, the credibility of our results also relies on whether individuals can forecast their Social Security benefits. There is evidence that the majority of people have relatively accurate expectations about their future Social Security benefits, and that the accuracy improves closer to retirement (Rohwedder and Kleinjans, 2006).

There has been other recent work using similarly stated choice data to look at retirement-related issues. For example, Luttmer and Samwick (2015) investigate the welfare loss faced by households due to political uncertainty associated with their future Social Security benefits. Like us, they ask survey respondents hypothetical questions about how they would change behavior (savings, labor supply, bequests) if their benefits could be guaranteed. Maurer et al. (2017) use a similar approach asking respondents to report their expected claiming age under various benefits payment options (e.g., lump sum). Michaud and van Soest (2008) investigate the impact of the 2000 repeal of the earnings test above the normal retirement age on retirement expectations (i.e., individual-specific subjective probability to work full-time past ages 62 and 65) of male workers. Van Soest, Kapteyn and Zissimopoulos (2007) investigate preferences for full and partial retirement by asking survey respondents to rate several hypothetical retirement trajectories involving early retirement, late retirement, and gradual retirement, each with its own corresponding income path. The major difference with respect to this literature is that we consider a different policy, that is realistic and salient for the sampled population: a 30% cut of Social Security benefits. Moreover, and importantly for policy, we can link these responses to the rich data elicited in the HRS, including linked Social Security earnings records which allow us to assess how individuals’ behavioral response partially offsets the loss in benefits and to determine the actual change in the annual Social Security benefits post-reform.

We designed a survey module that elicited stated choice data from a subsample of respondents to the Health and Retirement Study (HRS) who were interviewed over the Internet in the summer of 2007. We link their answers to the rich background information collected in the HRS core survey and to administrative Social Security earnings records. About three quarters of our respondents report that they would “definitely” adjust their behavior in the case of a 30 percent cut in their Social Security benefits. Thirty-six percent report that they would only reduce spending, while another 30 percent report that they would both work longer and reduce spending, underscoring the importance of considering these options jointly. At a qualitative level, we find important differences in the response by marital status, working status, and socioeconomic status (SES). Non-workers and those living in a couple are less likely to report that they would “definitely” work longer or reduce spending, while the opposite is true for those with lower education and those belonging to a lower wealth tertile.

We investigated the magnitude of the adjustment in terms of spending and find that respondents would on average reduce their spending by 18.2 percent before retirement, and by 20.4 percent after retirement. About two-thirds of the respondents who would consider reducing spending before retirement would start doing so immediately after the reform’s enactment. We also conducted a more detailed quantitative analysis of respondents’ answers about delaying their claiming of Social Security benefits. On average, Social Security claiming would be postponed by 1.08 years. We investigate how working longer and claiming Social Security later would compensate partially for the loss in benefits among the individuals who are currently working. If this time was spent working by everyone, then the annual Social Security benefit would be adjusted upward because of both the additional earnings and the fact that there would be less of an early claiming penalty or a higher delayed claiming credit.3 Rather than experiencing a 30 percent drop in the annual benefit, respondents would experience a 21 percent drop on average when taking into account their adjustments to claiming later and working longer. Comparing the change in the present value of future Social Security benefits to the change in the present value of future earnings to assess the net financial effect we find a median net loss of $9700 or 3.5 percent of median wealth holdings.

Section snippets

Data: The HRS Internet Survey

The data on individuals’ responses to a 30 percent Social Security benefit cut come from a module of the Health and Retirement Study Internet Survey, which is a supplementary survey of the HRS.4 The HRS is a panel survey that is representative of the U.S. population ages 51 and over. In the core survey, the HRS collects data on close to 20,000 individuals and their spouses in about 13,000 households. Eligibility for the second wave of the

Heterogeneity in qualitative response

The response to a cut in Social Security benefits is likely to vary by individual and household characteristics. We investigate this in a multivariate framework using a bivariate probit model. This approach accounts for the fact that the decisions of whether to work longer or whether to reduce spending are determined jointly. As before, the dependent variable “work longer” takes the value one if the respondent answered “Definitely Yes” to either “work longer” or to “claim Social Security

Quantitative assessment of the reduction in spending

Respondents who answered “Definitely Yes” or “Maybe” to the option “spend less before retirement” were asked whether they would reduce their household spending immediately or how many years they would wait to do so, and by how much they would reduce their spending (to be stated in percent). Those who answered “Definitely Yes” or “Maybe” to “reduce spending after retirement” were also asked by how much in percent they would reduce their spending. The rate of item non-response is very low on

Quantitative assessment of the response to delay claiming Social Security benefits

We now turn to quantifying individuals’ response with respect to delaying claiming Social Security benefits. We focus on this particular aspect for two reasons. First, from the point of view of the Social Security program, changes in the timing of claiming Social Security affect the finances and cash flow of the Social Security program directly and are therefore important in understanding the implications of the reform scenario. Second, the data for measuring the size of the response are more

Comparison with existing studies

Our stated choice analysis relies on the assumption that respondents are able to accurately predict what they would do under the hypothetical scenario. To further examine the credibility of this assumption, we compare our results to those found by other studies investigating the impact of a Social Security reform using relatively recent cohorts. This exercise provides solely suggestive evidence as it is hard to make precise comparisons between existing studies and ours due to different sample

Conclusions

Social Security is the most important source of retirement income for a large fraction of the population. Any prospective Social Security reform to return the program to long-term solvency is likely to involve benefit cuts of some form or another. In this paper, we investigated how individuals in their 50 s and 60 s would change their spending and/or labor supply if everyone’s Social Security benefits were cut by 30 percent. In the absence of data on actual Social Security benefit cuts in the

Acknowledgements

We are grateful for funding from the U.S. Social Security Administration (SSA) via the Michigan Retirement Research Center (UM08-08) and from a grant from the National Institute on Aging (P01AG008291). Delavande also acknowledges support from the Economic and Social Research Council Research Centre on Micro-social Change (ES/L005999/1). We thank participants of the Social Security workshop at the 2008 NBER Summer Institute, a seminar at the Mannheim Institute of Ageing and the conference on

References (3)

  • Health and Retirement Study, wave 2006, public use dataset. Produced and distributed by the University of Michigan with...
  • Health and Retirement Study, 2007 Internet Survey. Produced and distributed by the University of Michigan with funding...
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