Estimating Earnings Adjustment Frictions: Method and Evidence from the Social Security Earnings Test

66 Pages Posted: 28 Aug 2014 Last revised: 24 Nov 2017

See all articles by Alexander Gelber

Alexander Gelber

National Bureau of Economic Research (NBER); University of California, Berkeley

Damon Jones

University of Chicago - Irving B. Harris Graduate School of Public Policy Studies

Daniel W. Sacks

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2017

Abstract

Recent literature has documented that individuals face frictions in adjusting their earnings with respect to policy, but this literature has not yet developed a method for estimating earnings adjustment costs. We introduce a method for estimating the cost of adjusting earnings, as well as the elasticity of earnings with respect to the incentive to earn. Our method uses information on the amount of bunching in the earnings distribution at convex budget set kinks before and after policy changes in the earnings incentives around the kinks: the larger is the adjustment cost, the smaller is the absolute change in bunching from before to after the policy change. We apply this method in the context of the convex kink created by the Social Security Annual Earnings Test (AET). Using a one percent sample of earnings histories from Social Security Administration micro-data, we show that individuals continue to bunch at the kink formerly created by the AET even when they are no longer subject to the AET, indicating that they must face adjustment frictions. We estimate in a baseline case that the earnings elasticity with respect to the implicit net-of-tax share is 0.35, and the Öxed cost of adjustment is around $280. Our results demonstrate that the short-run impact of changes in the e§ective marginal tax rate can be substantially attenuated, which can inform projections of the timing of earnings responses to tax and transfer policies.

Suggested Citation

Gelber, Alexander and Jones, Damon and Sacks, Daniel W., Estimating Earnings Adjustment Frictions: Method and Evidence from the Social Security Earnings Test (November 1, 2017). Available at SSRN: https://ssrn.com/abstract=2487382 or http://dx.doi.org/10.2139/ssrn.2487382

Alexander Gelber (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Damon Jones

University of Chicago - Irving B. Harris Graduate School of Public Policy Studies ( email )

1155 East 60th Street
Chicago, IL 60637
United States

Daniel W. Sacks

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy ( email )

Bloomington, IN 47405
United States

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