Social Security and Retirement Decisions

One of the most striking features of the postwar U.S. economy has been the rapid decrease in the labor force participation of the elderly at a time when the health of this group has been improving. In spite of this, previous research, based on retrospective interviews with the retired population, usually concludes that poor health accounts for the overwhelming majority of retirements. This paper suggests that nothing could be further from the truth. Using data from the Panel Study of Income Dynamics, we follow a cohort of white married males through their sixties to estimate a model of retirement behavior. Using several definitions of retirement suggested in the literature, we find that the two key policy parameters of the social security system—the income guarantee and the implicit tax on earnings—exert an enormous influence on retirement decisions. For example, our results suggest that a decrease in the implicit tax rate on earnings from one-half to one-third would reduce the annual probability of retirement by about fifty percent! Applying the coefficient estimates to time series data on the labor force participation of the elderly implies that the social security system has been the major factor in the explosion in earlier retirement.