Earnings test, non-actuarial adjustments and flexible retirement

fredag, 13 oktober 2017

In response to the challenges of population aging, many countries have introduced gradual increases of the statutory eligibility age and shut down pathways to early retirement. There are, however, many incentives left which create early retirement, in particular earnings tests and less than actuarial adjustmaent rates, both of which are still frequent in Europe.

This paper analyzes whether and to what extent abolishing earnings tests will strengthen the sustainability of public pension systems.

We employ a life-cycle model of consumption and labor supply where the choices of labor force exit and benefit claiming age are endogenous and potentially separate. Earnings tests force workers to exit the labor market when claiming a pension. After abolishing the earnings test, workers can claim their benfits and can keep on working, potentially increasing labor supply. The difference between exit and claiming age strongly depends on the actuarial neutrality of the pension system and can become very large.

We show that abolishing an earnings test as part of a "flexibility reform" creates more labor supply but at the same time reduces the average claiming age when adjustments remain less than actuarial, thereby worsening rather than improving the sustainability of public pension systems.