Labor Supply and Retirement Decisions Xiaodong Fan Ananth Seshadri and Christopher Taber UNSW and University of Wisconsin July 31 2017 Basic Goal Modeling retirement behavior is fundamental to understanding effects of policy changes on retiree wellbeing ID: 1027261
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1. Understanding Earnings, Labor Supply and Retirement DecisionsXiaodong Fan, Ananth Seshadri, and Christopher TaberUNSW and University of WisconsinJuly 31, 2017
2. Basic GoalModeling retirement behavior is fundamental to understanding effects of policy changes on retiree well-beingThe goal of this work is to estimate a human capital investment model with labor supply to jointly explainLifecycle profiles of wagesLifecycle profile of labor supplyMain Goal: Retirement arises endogenously as a labor supply decision in which individuals optimally bunch leisure late in life
3. Build a model that can reconcileThe large increase in wages and small increase in labor supply at the beginning of the lifecycleThe small decrease in wages and large decrease in labor supply at the end of the lifecycleTry to explain this without allowing preferences or technologies to depend explicitly on age.The Challenge
4. Why do we care?Human Capital literature: endogenizes lifecycle wages taking the retirement date as exogenous. Retirement date is crucialRetirement literature: endogenizes retirement taking the wage pattern as exogenous. Wage pattern is crucialOur goal is to endogenize both within the same modelMatters for social security policy questions: if changes in social security system induces people to retire later, human capital investments will change
5. DataWe use SIPP Large panel data setWe condition on white males with exactly 12 years of educationWe have data on essentially “worked last week” and “wage last week”Consider the mean profiles by age (estimation focuses on 22-65)
6. Shape of the wage profile near retirement is crucialHowever, there is a major “selection problem” in that we only observe wages for non-retireesA simple solution is to use fixed effects.Here we run a regression of log wages on age dummies and individual specific fixed effectsWe plot the estimated age dummies along with mean log wagesSome Considerations
7. Log Wages
8. The Baseline Model Extensive margin of labor supplyIndividuals maximize utility from consumption and leisureHuman capital investment makes earnings endogenousTime used for work, human capital accumulation or leisure We account for social security rules and taxesSince Heckman (1975,1976) very little work combining Human Capital theory with Labor supply
9. In the data we see almost flat wages but a large decline in labor supply for middle age/older workersDifficult to explain this without a very large labor supply elasticityWhy are people working so little when they are old even though their wages appear high?Two features of our model will help explain this Other than social security, precautionary savings, and selection on wagesModel Features
10. 1. DepreciationThere is a shadow cost to not workingHuman capital depreciatesEven middle age workers need to invest in human capital or their wages will declineIn the simplest labor supply model if wages were the same at age 50 and 70 there is no reason why labor supply should be lower at 70 than at 50. Individuals don’t "retire” during their middle ages because of depreciation, when they return at 60 their wages would be very low
11. 2. Wages and human capital are differentMeasured wages are(1 − It) HtMeasured wages can remain flat when Ht is falling if It is falling as well.Since lifecycle It declines as people age, human capital has to fall faster than wagesCan reconcile a relatively small decline in wages with a relatively big decline in labor supplyWithout resorting to a very large labor supply elasticity
12. We estimate using Indirect Inference with six sets of moment conditions from SIPP to represent the life-cycle profiles.The labor force participation rate 22-65;The first moments of the logarithm of wages 22-65;The first moments of the logarithm of wages after controlling for individual fixed effects 22-65;The second moments of the logarithm of wages 22-65; The first moments of consumption 27-65;The overall transition rates: E to U and U to E.Total Sample Size: 230,657 observations from 80,519 individualsMoments
13. Parameter Estimates Baseline ModelParametersEstimatesStandard ErrorsLeisure: Standard Deviation of Shockaε0.433(0.012)Human Capital Depreciationδ0.101(0.007)Human Capital Production Function: I factorαI0.076(0.019)Human Capital Production Function: H factorαH0.151(0.021)Standard Deviation of Human Capital Innovationσξ0.405(0.082)Bequest Weightb1424, 070(90, 735)Parameter heterogeneitybLeisure: Mean of Interceptµa0−6.525(0.050)Leisure: Standard Deviation of Interceptσa00.874(0.053)Human Capital Productivity, Meanµπ1.758(0.069)Human Capital Productivity, Standard Deviationσπ0.583(0.026)Correlation between a0 and πρ−0.893(0.064)Initial Human Capital Level at Age 18Interceptγ01.625(0.099)Coefficient on a0γa00.052(0.007)Coefficient on πγπ0.531(0.060)Standard Deviation of Error TermσH00.239(0.036)
14. Fit of Labor Force Participation
15. Fit of Log Wages with Fixed Effects
16. Fit of Log Wages without Fixed Effects
17. Fit of Standard Deviations of Log Wages
18. Fit of Consumption
19. Here is what happens in the model
20. Simulation of Main Variables
21. Human Capital and “Wages”
22. Labor Supply Elasticity
23. HealthOne potentially important element of the model is health-we include it to see it’s quantitative significanceHealth status is a new state variableAffects tastes for leisure, and interact this with ageWe estimate transition from PSIDWe fit age pattern of interaction between health and Age (from CPS)It appears to be relatively unimportant
24. Sensitivity of Labor Force Participation to Health Status
25. Log Wages
26. We conduct several counterfactual policy experimentsIncrease Tax Rate by 50%Remove the Social Security earnings test, Delay Normal Retirement Age (NRA) two yearsRemove the Social Security system completely Remove the Social Security system-taxes only Remove the Social Security system-benefit only Decrease the Social Security benefit by 20%Policy Counterfactuals
27. Baseline LevelIncrease Tax 50%% changeNo Earnings Test% changeNRA = 67% changePanel A: Baseline ModelLFPR40.3563.0960.9591.012Effective Labor37.9973.1250.9571.006Pre-tax Income637.7594.5210.9161.330Average lnw2.6130.4680.3220.268Human Capital917.3822.8230.7050.836Investment2.3592.6310.9881.122Panel B: Exogenous ModelLFPR40.4123.7710.2080.835Effective Labor40.4123.7710.2080.835Pre-tax Income655.2583.9450.2740.799Average lnw2.6250.2480.0150.024
28. Baseline LevelReduce SSB 20%No SSTaxesNO SSBenefitNO SSPanel A: Baseline ModelLFPR40.3561.570-4.82612.9346.560Effective Labor37.9971.563-4.79012.9266.585Pre-tax Income637.7592.165-7.14315.2805.826Average lnw2.6130.569-0.7771.9030.792Human Capital917.3821.326-4.3548.9463.681Investment2.3591.684-5.39513.0596.147Panel B: Exogenous ModelLFPR40.4121.311-5.4758.5522.245Effective Labor40.4121.311-5.4758.5522.245Pre-tax Income655.2581.264-5.1187.7052.030Average lnw2.6250.076-0.103-0.009-0.069
29. ConclusionModel is able to fit wage and labor supply profiles wellModel produces retirement endogenouslyDepreciation of human capital is really key to understanding retirement decisionsAnd Health shocks play a much less important rolePolicy responses to changes in SS benefits are meaningfully different from model with exogenous wage processes