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The Review of Economic Studies, Ltd.

Social Security, Unanticipated Benefit Increases, and the Timing of Retirement

Author(s): Gary Burtless
Source: The Review of Economic Studies, Vol. 53, No. 5 (Oct., 1986), pp. 781-805
Published by: Oxford University Press
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Review of Economic Studies (1986), LIII, 781-805 0034-6527/86/00480781$02.00

? 1986 The Society for Economic Analysis Limited

Social Security, Unanticipated

Benefit Increases, and the Timing

of Retirement
Brookings Institution

Between 1969 and 1972, real U.S. social security retirement benefits rose by 20%. The rise
was unanticipated and followed over 15 years of relatively constant real benefits. This paper
proposes a model of retirement behaviour in which workers respond differently, although in a
theoretically consistent manner, to the anticipated and unanticipated components of the social
security benefit they can receive upon retirement. The retirement age decision in the presence of
unanticipated benefit changes is shown to be a special case of utility maximization under a
nonlinear budget constraint. The model is estimated using the Longitudinal Retirement History

Between 1969 and 1973 real social security benefits for U.S. workers with fixed earnings

histories were raised by more than 20%. These increases were the first significant increases
in social security since the early 1950's. At the same time that retirement benefits were
rising, the trend toward early retirement among older American men accelerated. In the

period from 1965 to 1970, the labour force participation rate of men aged 55 to 64 fell

1 6 percentage points, from 84X6% to 83'0%. But in the five years after 1970, the rate
fell an additional 7 4 points to 75 6%. The participation rate of men over 65 fell by 1 1

points in the five years after 1965 but by 5-2 points during the mid 1970's.1 Not surprisingly,
a large share of this labour force decline has been attributed to the effects of the social
security increases enacted in 1969 and 1972. The purpose of this paper is to determine
the precise effect of the unanticipated benefit increases on the timing of retirement.
The effect of social security on the age at retirement has been the subject of lively
debate in recent years. The literature has been reviewed in two recent papers by Mitchell

and Fields (1982) and Hurd (1983), who reach nearly opposite conclusions about the
lessons that can be drawn from past empirical research. Mitchell and Fields find that no

definite judgment can be reached about the effects of social security on retirement, while
Hurd argues that more careful studies have all found a significant and meaningful effect

of social security on early retirement. Certainly the earlier studies, by Boskin (1977) and
Boskin and Hurd (1978) found very large social security effects, with Boskin concluding
that ". . . the social security system has been the major factor in the explosion in earlier

retirement" (Boskin (1977), p. 1). Very recent studies by Burkhauser and Quinn (1983),

Burtless and Moffitt (1984), Diamond and Hausman (1984), Fields and Mitchell (1984)
and Hausman and Wise (1985) have found smaller social security effects. However, none
of them dealt explicitly with the rapid rise in real benefits during the early 1970's.
The approach taken in this paper differs significantly from that in the earlier research
just cited. The proposed econometric model takes full account of the nonlinear relation-

ship between goods consumption and the age at retirement introduced by social security.

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In contrast to past retirement research, the model is general enough so that the unforeseen
changes in social security benefits in 1969 and 1972 can be explicitly represented and
then accounted for in the estimation. Unanticipated changes in the social security formula
raise special problems in estimation. A worker who has already retired at the time a

benefit rise is announced cannot retire at a younger age. A worker who has not yet retired
may retire at a younger age than if benefits had remained unchanged, but at a later age

than if the benefit increase had been implemented many years earlier. This response
highlights the importance of explicitly controlling for unanticipated benefit changes when

devising an estimation strategy. This is especially true of research based on the Panel
Survey of Income Dynamics, National Longitudinal Surveys, and Retirement History
Survey, because each of these panel surveys covers the period including 1969-1973 when
social security benefits were rising sharply.
The organization of this paper is as follows. In the first section I outline a model
of retirement behaviour and show how social security benefits affect the timing of

retirement. The effects of the basic social security formula are examined and a detailed

estimation strategy is proposed. The second section contains a discussion of the social
security formula changes that are relevant to the sample studied in this paper and then
outlines an estimation strategy that accounts for these changes. The following section
presents a discussion of the data as well as estimates of the structural retirement age
model. The fourth section provides estimates of the short- and long-run effects of a

variety of social security changes, including the changes legislated in 1969 and 1972.

Contrary to some earlier analysts, I do not find that benefit increases enacted in those
years were the major reason for the decline in male labour force participation during the

1970's and early 1980's. The final section contains a brief summary of conclusions and
indications of potentially useful future research.


All plausible models of retirement behaviour must be based, implicitly or explicitly, on

a lifetime model of consumption. Retirement is defined in this paper as a discontinuous

drop in labour supply not connected to a spell of unemployment that ends in reemployment in a full-time job. Workers ordinarily retire only once in a lifetime. Although
temporary factors, such as unemployment, depressed wages, and short-term illness, may
affect this decision, the basic decision to retire also involves longer term considerations.
If a worker retains the ability to earn wages, the decision to cease working at a particular

age reflects a choice to forego goods consumption that could be financed out of future

earnings. On the margin, the goods consumption that could be financed by an additional
year of preretirement work must appear less attractive than an added year of retirement
leisure. The net amount of goods consumption foregone is the "price" of a year of
retirement leisure. This price has several components. In the simplest case, where a
worker is paid straight money wages at a constant rate of W dollars per year, the price

of postponing retirement by one year from, say, age R to age R + 1 is W if wage earnings
completely cease upon retirement. (To keep the exposition simple, the discount rate and

the rate of wage growth are assumed to be zero, assumptions that will be relaxed below.)
The tradeoff between goods consumption and retirement is represented as the straight

line AB in Figure 1. Starting at an arbitrary age, say age 54, the line AB shows the levels
of potential goods consumption that can be financed with successively later ages of
retirement (R).2 (The left-hand intercept, A, reflects the initial assets endowment or the
level of savings that has been accumulated by age 54.)

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Potential goods







Age at retirement (R) _


Tradeoff between goods consumption and age at retirement

Social security affects the lifetime tradeoff between goods and retirement leisure
consumption in a complex way. Workers who become vested in the U.S. system are
eligible for a certain retirement benefit, payable at age 62 or at retirement, whichever
occurs later. Because the social security system has historically been quite generous, all
beneficiary cohorts up to the present have received benefits that have far exceeded
contributions. This generosity has the effect of raising a worker's lifetime constraint,
including social security, above the no-social-security constraint, AB. As retirement is
delayed, and covered earnings increase, the monthly social security entitlement rises by
an amount that varies at different ages. For workers retiring before age 62, a delay of
one year in retirement yields an increase in lifetime social security benefits equal to
( T-62) * (dB/ dR), where T is the age at death, T-62 the number of years of benefit receipt

and dB/dR the rise in annual social security benefits to which the worker is entitled by
virtue of working an additional year. The worker also makes an added year's contribution
to the social security system, but this amount is generally lower than the extra benefits
he can expect to receive from social security in the future. Consequently, by delaying

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retirement for a year a worker gains social security benefits in addition to straight money
wages. Social security thus has the effect of raising the slope as well as the intercept of

the lifetime constraint before 62. The amount by which the slope is affected will depend,
of course, on the rate of gain in future social security benefits, which in turn depends on
the intricate formula relating benefits to covered earnings.
Workers who postpone retirement past age 62 are at least temporarily passing up
the opportunity to receive social security benefits, which can commence at a retiree's
62nd birthday. Unless the growth in benefit entitlements, dB/ dR, is enough to offset the
loss of a year's benefits, a worker who postpones retirement (and benefit receipt) after
62 is reducing his lifetime social security benefits each year that he delays retirement.
Between ages 62 and 65 an actuarial adjustment factor is applied against the basic benefit
which generously compensates workers for the delay in benefit receipt. After age 65,
however, the social security formula is markedly less generous, and further postponements
in retirement after that age are not fairly compensated by increases in the annual benefit

The implications of social security for the lifetime budget constraint are summarized
in Figure 1. The vertical distance between the two lines is equal to the social security
wealth that has been earned by a particular age. At age 62 the rate of rise of lifetime
benefits with respect to the retirement age changes. If the actuarial adjustment in benefits
is less than fair, the rate of change of benefits must decline, and the slope of the lifetime
constraint must fall. If the actuarial adjustment is more than fair, the rate of change of
benefits will rise, and the slope of the lifetime constraint must increase. At a discount
rate of 0 percent, assumed in Figure 1, the acutarial adjustment factor (8%) is more than

fair for many older men, so I have drawn the social security constraint, CDEFG, with a
nonconvex kink at point D, which corresponds to potential retirement at age 62. At age
65 the actuarial adjustment factor falls, so the decline in the rate of growth of lifetime
social security benefits must correspond to a reduction in the slope of the lifetime
constraint. This is indicated by a convex kink at point E. Before age 65 the system
provides workers with greater lifetime wealth and so offers an inducement to retire earlier
if retirement leisure is a normal good. However, it also raises the price of retirement by
providing higher future benefits for each added year of work. The net effect on retirement
prior to age 65 is thus indeterminate. After age 65 the program provides an unambiguous
incentive to retire earlier, because it raises lifetime wealth and lowers the reward to
marginal work in comparison to the no-social-security world. In addition, the program
provides a powerful inducement for some workers to retire at exactly age 65 since at that
age the marginal return to work falls markedly.
The analysis can be extended in a straightforward way to take account of taxes, wage
growth, mortality probabilities, and a nonzero discount rate. The fact that wage income
and possibly retirement income are taxed implies that the lifetime resources available for
goods consumption are less than previously suggested. If the tax rate on preretirement
wages, including the social security tax, is tp and the tax on retirement benefits is tR then
a worker who retires at age R has lifetime resources of

Y = A' + (R - 54) * W- (I - tp) + ( T-max (62, R)) * B(R) * (1 - 0R, I1

where A' is the amount of consumption that can be financed, after taxes, out of wealth
available at age 54; T-max (62, R) is the number of years of social security benefit receipt;

and B(R) is the annual social security entitlement due if the worker retires at age R. If
real wages are growing at rate gw, the probability of survival to age a iS- Sa, and the rate

of discounting of future income is d, lifetime resources from the perspective of a worker

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aged 54 are;

Y-A+Z R-1 Sa* W (1 +gW)a-54. (1- tp) T Sa * B(R) (1- tR)

a=54 (1 + d)a54 a=rmax(P., 62) (1 + d)a-54 (2)
(W is now the worker's gross annual wage at age 54.)
The budget constraint implied by (2) is more complicated than, though similar in
general outline to, the stylized constraint drawn in Figure 1. The most important nonlinearities in the social security constraint occur as before at ages 62 and 65. At age 65
the social security formula unambiguously introduces a convex kink as shown at point
E along the constraint CDEFG in Figure 1. At age 62 the nature of the kink will depend
critically on d, the rate of discounting. With low rates of discount, the budget constraint

may be nonconvex (i.e. will appear as drawn at point D in Figure 1). By implication, at
low values of d workers may systematically avoid retirement at age 62. With high values

of d, on the other hand, the budget constraint at age 62 will be convex; some workers
will have an incentive to retire at precisely that age.4

Changing earnings opportunities also affect retirement decisions. Older workers who
are permanently laid off have difficulty obtaining well-paid jobs. Workers with unexpected

health problems may have trouble continuing to work at the same level or on the same
job. A few workers face mandatory retirement rules which force them to leave a particular
job earlier than they otherwise would. There are, of course, factors that work in the

opposite direction. Some workers find that their real wage5 rise faster than anticipated.
Conditions of employment may improve, lessening the hardship of continuing to work.
The estimation model described below takes account of the effects of unexpected events
on retirement.

A last possibility worth considering is partial retirement. In measuring the price of

retirement I have assumed that workers do not work after retirement. Some workers do.
In an earlier paper based on the same data set and retirement definition used here, Burtless

and Moffitt (1984) found that 18% of retired men held part-time jobs within two years
after their retirement. However, the level of hours (18 hours per week) and earnings were
comparatively low. Gustman and Steinmeier (1983) report that the average duration of
partial retirement is only about three years. By implication partial retirement accounts
for only a very small proportion of lifetime labour supply. It will be ignored in this
paper, and partial retirement will be treated as indistinguishable from full retirement.5
Viewed in a lifetime context, the economic theory of retirement is an application of

ordinary utility maximization. Workers face a given price of retirement consumption,

with the price measured in terms of a composite consumption good. Individuals choose
a desired retirement age corresponding to the most preferred point on their lifetime budget

constraint. In Figure 1, R* is the age corresponding to this utility maximum. The statistical
estimation problem would be straightforward if the price of retirement were constant.
The demand for retirement leisure consumption could then be estimated using an equation
of the form





where R is the observed retirement age, w is the "price" or "net wage" of continuing to
work in terms of goods consumption per added year of retirement, n is the wealth level

at some arbitrarily selected initial age (but equal for each observation), and E is a random
error term. As described earlier, however, the budget constraint is not even approximately
linear except between kink points along the constraint. There is therefore no single price

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and wealth combination that can be used in estimation, because each worker faces a

schedule of prices and "virtual wealth" levels that vary depending on the retirement age.
The econometric problem is similar to ones discussed in Burtless and Hausman

(1978) and Hausman (1981), although the social security increases in 1969 and 1972
introduce an important complication. For the moment we ignore these increases and
consider the case where the schedule of prices remains fixed over a worker's later working
career. After empirical specification search of alternative forms of the retirement demand

function, I found the following form yielded the most promising results:

R= yZ+a ln(w)+,l3 n (n)+e, (4)

where R is the age at retirement, Z is a set of personal characteristics that affect retirement,
such as health and marital status, w and n are the slope and intercept of the lifetime

constraint, E is a normal disturbance term, and y, a, ,, and o-, are unknown parameters
to be estimated.6 In this specification, E is a random error arising from both measurement
error and the divergence between planned and actual retirement. Some of the reasons
for this divergence have been enumerated above. In addition workers will differ in their
planned ages of retirement because they systematically differ in tastes for retirement
leisure. Given the same wealth and facing an identical schedule of retirement prices, two

workers do not necessarily plan to retire at the same age. This heterogeneity of preferences
can be represented as a random distribution in a or ,, two utility parameters that index

individual preferences. In this paper , is assumed to vary across individuals as a random

normal deviate, - N(,, o-,p). Thus, P and E have a bivariate normal distribution. There
are good reasons to believe that the correlation of , and E, p,,,, may be negative. High

values of ,3 are associated with later planned retirement ages. A worker planning to retire
late is more likely to be forced to retire before planned than is a worker wishing to retire

Another behavioural parameter of interest is d, the rate of discounting of future wage

and benefit streams. As mentioned above, this parameter is critical in determining the
exact location and even the overall shape of the lifetime constraint. Rather than assume

a value for this parameter, as has been done in previous research, I estimate its value in

the data. However, examination of (2) shows that d enters the budget constraint in a
highly nonlinear fashion. To estimate d using this form would require a highly complex
as well as costly likelihood function. This can be avoided by using a simple approximation
to year-by-year discounting. In particular, a worker's life span can be divided into fewer

than T-54 periods for the purpose of estimating the discount factor. In this paper I
simply divide each worker's remaining life span into two periods. Dollars earned or
received in period 1 are undiscounted; dollars received in period 2 are valued at rate 0,
where presumably 0? 0 _ 1. If 0 = 1, dollars would be valued equally regardless of when
received; if 0 = 0, they would have no value, and hence would not affect behaviour in

period 1. To implement this suggestion, the lifetime budget constraint is written

Y(R) = A' + Ei R-1 Sa * W. (I + gWy-54 . (I _ tp)

+ama(, s2 S B(R) (10 tR)+ 0 ET2+1 Sa * B(R) * (- tR) (5)

where T1, assumed here to be 71, is the last year in period 1 and T2 is the last year in
period 2, i.e. the oldest possible age, here assumed to be age 100. (To ensure that the
results were not dependent on the specific choice of T1, I tried an alternative value in

estimation.) The price of retirement at age R is w = dB/dR, which consists of two

components, a change in income received in period 1 and a change in income received

in period 2, say, wl and w2, respectively. Similarly, the "virtual wealth" of a worker, n,

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consists of wealth allocatable to period 1, nl, and wealth allocatable to period 2, n2. The
full demand function for retirement, equation (4), can be rewritten as
R = yZ+ a ln (w + Ow2) + (, + ,u),ln (n + On 2) + ,



where , is a random normal disturbance , - N(O, o-,q) and R* is the planned retirement
age for a given budget constraint. The unknown parameters are cv = (y, a, ,l 0, (- o- u,
PO3?) which can be estimated using the method of maximum likelihood.
Before describing the likelihood function in detail, it is worth considering some
assumptions that underlie it. A central assumption is that individuals act with good
information about their future wages and social security entitlements. Unexpected
economic events, such as trade shocks and recessions, can affect a worker's market wage,
but such events are difficult to account for in the context of a model in which the lifetime
constraint is well defined at some initial age, say age 54. Similarly, unexpected events
such as health impairment, death of a spouse, or divorce can affect the economic variables
which determine retirement. Within this model, the effects of these events are captured
in the error term, E, although it would be desirable to capture them in a more direct way.
The model also constrains different forms of income to have an equivalent effect on
behaviour. For example, compensation received as current wages and as future social
security benefits is treated equivalently except for the discount factor, 0. This is certainly
the customary presumption in economics, where income is usually treated as equivalent
regardless of its source. One could argue, however, that a dollar of money wages to be
received in a future year is not treated by workers as equivalent to a dollar of social
security benefits obtainable in the same year. In a more general version of the model,
the hypothesis of nonequivalent effects could be formally tested. I have not chosen to
test it here in order to keep the exposition and estimation straightforward.
My model of retirement can be contrasted with the radically different models proposed

by Diamond and Hausman (1984) and Hausman and Wise (1985). Both sets of authors
rely on a sophisticated version of the hazard or time-to-failure statistical model, first
applied in economics to the problem of measuring the duration of a spell of unemployment

(see Lancaster (1979)). The hazard model has the considerable advantage that it permits
the analyst to measure the current effect of variables that have recently changed in value.

Hence, it can capture the effects of varying health and market wage rates in a natural
way. Unfortunately, the hazard model is not grounded on a utility-maximizing theory of

behaviour, so it cannot be easily extended to measure the impact of expected future

changes in relevant economic variables, for example, the kink points and overall shape
of the lifetime budget constraint. Later on I will compare my own findings with those
based on the hazard rate model.

We now turn to details of constructing the likelihood function. There are two types

of observations, those which have an observed retirement age and those where no
retirement occurred before the last interview in the panel survey. For each observation,
the likelihood function has two types of terms, corresponding to a utility maximum along

a linear budget segment and at a convex kink point, respectively. I will briefly describe
each term, first for retirees and then for nonretirees.

A worker will have a global maximum along a linear budget segment that starts at
age dj and ends at age aj if his taste parameter p lies between two critical values, say
f3j and 4, (j is used to index the segment between a and a as the j-th budget segment
on the lifetime constraint). The lower limit, j3>, corresponds to a global utility maximum
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precisely at da, implying fi = [aj - yZ - a In (wj)]/ln (nj). The upper limit similarly corre-

sponds to a global maximum at age ad and is ,i = [dA - yZ - a ln (w,)]/ln (n1). Defining

R* so that E = R-R= R -[yZ+a ln (wj)+ ln (nj)], the probability of observing the
retirement age R when the utility maximum lies along segment j is

PR(Segj) =

( 1 _-p2)-1/2

x exP{2(12) [(3-)22p(-)(R-Rj) (RR )1}d2 (7)

If there are Si linear segments, the likelihood function for the i-th observation will contain
Si terms like (7), each corresponding to a maximum on a different segment.
The worker will have a global utility maximum at the k-th kink point, with associated
retirement age ak, if the taste parameter lies between the critical values fk and 4k. The
lower limit, P1k, corresponds to the highest p on the segment that ends at ak, implying
Pk = [ak- yZ- a ln (wk1)]/ln (nk-1). The upper limit corresponds to the lowest p on
the segment that begins at ak, k= [ak- yZ -a ln(wk)]/ln (nk). The probability of
observing the retirement age R when the desired retirement age is ak is then

PR(Kinkk) =2 e2.Ao2
x I exp2 l (3 - 2p( )(R ak) + (R ak) dp. (8)
If there are Ki convex kink points, the likelihood function will contain Ki terms like (8,)
corresponding to maxima at the several kinks. Evaluation of (7) and (8) is straightforward,
since both expressions can be transformed into functions of the standard normal distribu-

tion. The sum of the Si + Ki terms just described is the likelihood of the i-th observation.
The likelihood terms are slightly more difficult to evaluate for nonretirees. A nonre-

tiree has R > L, where L is the recorded age at the last completed interview. (Note that
all observations, including those who completed only one of the six RHS interviews, can

be included in the estimation.) The likelihood that R is greater than L is just the probability

that E plus the optimal R, say R*, is greater than L, i.e. R* + E > L. This probability can
be computed once again by successively evaluating the probability that the global
maximum lies along each linear segment or convex kink. The probability of R > L when
the desired retirement age lies on segment j is

PN(Segj) = p2)


fJ { l expPP 2p(2-/3)+ ? dd, (9)
whL-R, 2(1 )3 and R
where ,8j,, and Rj* are defined as above. The probability of R > L when the desired

retirement age is the retirement age at the k-th kink point, ak, is

P (Kinkk) _ ( p)2


f0 k 0 - (f-8)2 2p(p8-fl)r- E

xJ J exp j 2/[ 2 - + Ajd8dP& (10)

1k L-ak 2(1 p) 3 ) 0 O

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Expression (10) is easily evaluated using approximations of the standard bivariate normal
distribution function, while (9) can be readily transformed into an evaluatable form of
the same distribution function.
The likelihood function for this problem is then

L(t) = fIRetirees Prob (R = R* + E)HNonretirees Prob (L < R* + E)

= Retirees[4 =i PR (Segj) + Ek=1 PR (Kinkk)]

X HlNonretirees [ -, PN(Segj) +ZKL PN(Kinkk)]. (11)

One complication arises in finding the maximum of (11) if the budget constraint is
nonconvex rather than convex. Consider the two-segment constraint in Figure 2. If 0 is
sufficiently high (i.e. if the rate of time preference is sufficiently low) the budget constraint
at age 62 will be nonconvex rather than convex. In that case, age 62 cannot be the highest
retirement age (a") on segment 1 representing a potential utility maximum nor the lowest

age ( 2) on segment 2 representing a utility maximum. This follows from the fact that a
Potential goods





Age at retirement-+

Simple nonconvex constraint

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nonconvex kink cannot be a utility maximum if indifference curves are everywhere

differentiable. To determine a, and d2 it is necessary to find the level of 13, say 13*, that
yields an indifference curve tangent to both segment 1 and segment 2. (The required
curve is drawn as BB in Figure 2.) 13* can be determined from the indirect utility function

giving rise to the demand function for retirement, equation (6). This utility function can

be obtained by integrating the demand function along a single indifferenc.e curve in price

space, dV = (a V/&w)dw + (a V/an)dn = 0. Taken with Roy's identity, (a V/dw)/(d V/an) =

-R, this yields the differential equation

-=-[yZ+a ln (w)+,3 In (n)]. (12)


Starting from the initial values w, and nl, as well as current parameter values for y, a,
and 13, equation (12) can be used to determine the location of a single indifference curve
in (w, n) space. Since (12) could not be solved analytically, I used standard numerical
methods to derive an indifference curve. By varying 13 for fixed values of y and a and
using standard iterative procedures, it is possible to find the value of ,B* yielding an

indifference curve in (w, n) space that contains both the pairs (wl, nl) and (w2, n2).7 The

solution value of 18* gives a, and d2 as well as the upper and lower bounds to integration
for deriving probabilities of a global maximum on the first and second budget segments.
(See probability expressions (7) and (9) above.) As it happens, the estimated value of
0, reported below, is low enough so that only an extremely small proportion of observations

are found to have any degree of nonconvexity in their budget constraints. For those
observations, the nonconvexity is very slight.

In this section I have outlined a model of retirement behaviour and suggested a

method of estimating it when the social security formula remains fixed over an individual's
later working life. In the next section I consider the benefit increases legislated in the

late 1960's and early 1970's. The resulting shift in lifetime budget constraints causes an
important complication in the estimation of workers' retirement preferences.


The real social security retirement benefit for a worker with a fixed earnings history
remained relatively constant over the fifteen-year span from 1955 through 1969. Many

aspects of the social security program were liberalized over that period, but because of
moderate benefit increases voted at irregular intervals the real benefit stayed remarkably

flat. Beginning with legislation passed in 1969, and effective in 1970, real benefits were
raised by about 20% in two discrete steps. Between 1970 and 1972 benefits were about

10% above the level prevailing between 1955 and 1969; after 1972 they were about 20%
above the old level. Since June 1974 benefits have been subject to automatic cost of living
adjustments to reflect changes in the consumer price index. The historical trend in social
security generosity is shown in Appendix A.
It is difficult to argue that the 1969-1973 benefit increases were foreseen by retirees
in the late 1960's and early 1970's and perfectly accounted for in setting retirement plans.

The 20% nominal benefit increase enacted in 1972, for example, passed Congress over

the opposition (though not the veto) of the Nixon Administration, which wished to

approve only a 5% benefit hike (see Derthick (1979)). In view of the legislative history
of the social security acts, it is more plausible to assume that potential retirees were

unaware of the possibility of major formula changes until shortly before they were actually
enacted. Of the four major pieces of social security legislation passed between 1969 and

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1973, the ones passed in 1969 and 1972 are the ones that significantly raised real benefits.
For this reason it is useful to divide the period from 1955 to 1979 into three distinct
regimes, with the first lasting through 1969, the second lasting until the benefit increase
in 1972, and the third commencing with the 1972 benefit hike.8
The effects of the two benefit increases on the lifetitne budget constraint of a worker
retiring after 1972 are shown in Figure 3. In the absence of benefit hikes, the lifetime

constraint would lie along the kinked budget constraint ABLMNP, with kinks at L and
N corresponding to nonlinearities in the social security formula for retirement at ages

62 and 65, respectively. At age a, real benefits were unexpectedly raised, with the increase
represented by the vertical distance BC. If the benefit increase had been fully anticipated
the lifetime constraint would have passed through A'CDE rather than ABLM, but the

unanticipated nature of the increase implies that between ages 54 and a, the worker
expected to receive lower lifetime benefits from social security than were actually made

available after a,. Similarly, at age a2 benefits are again raised unexpectedly leading to
another discontinuity in the lifetime constraint at point E. For a worker retiring later

than age a2, the lifetime constraint is thus the kinked line ABCDEFGH.

Potential goods






I ~~~~~~~~~~R



Age at retirement-+

Lifetime constraint with unanticipated benefit increases

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The nonlinearity introduced in the budget constraint by unanticipated benefit

increases is fundamentally different than the nonlinearity arising from the formula relation-

ship between social security benefits and retirement age. The important difference is that
the implications of the basic social security formula are understood in principle at age

54 or whenever retirement planning begins; the implications of a social security increase

are not known until the implementing legislation is passed by Congress.

Referring again to Figure 3, it is apparent that workers retiring before age a, must
have planned to retire on the basis of the lifetime constraint operative for regime 1

(ABLMNP). Even if their planned retirement age were greater than a, and would have
occurred in regimes 2 or 3, the relevant constraint to their decision could not have reflected

benefit increases enacted after their actual retirement.9 Workers retiring after a, but
before a2 could not have taken into account the effect of the second benefit increase,

although they would have been aware of the first benefit increase at ages above al.
Consequently, in planning their retirements these workers acted as though their constraint
were the kinked line ABLMNP until they attained age al. After that age they acted as
though their constraint were CDEQS. Similarly, workers retiring after age a2 would have
planned their retirements on the basis of constraint ABLMNP prior to age a1, on the

basis of constraint CDEQS after age a1 but before a2, and on the basis of constraint
FGH after age a2-

The unanticipated shift in budget constraints caused by a benefit hike clearly has
important implications for empirical estimation. If the effects of benefit increases are
ignored, either by computing benefits under a single social security law or using only a
local approximation of the lifetime budget constraint, the resulting estimates of

behavioural parameters may be biased. Use of a single formula to compute benefits will
distort the incentives provided by social security if a large fraction of workers retired
when a different formula was in effect. Use of a local approximation leads to a different
kind of problem, which may be seen by reference to Figure 3. Suppose a worker faced

with tLe budget line ABLMNP plans to retire at some age between a, and 62, that is, at
a utility maximum lying between prints B and L. As a result of a benefit increase enacted

at a, his preferred retirement age declines to an age less than a,, with an associated utility
maximum lying somewhere between points A' and C. Since time cannot be made to run

in reverse, his actual retirement age will be greater than a,. The local approximation of
his budget line will show his constraint to have the intercept and slope of segment CD,
but if he had actually been faced with that constraint starting at age 54 he would have
retired before age al.

With the econometric model outlined in the previous section, the estimation problem
becomes tractable. The likelihood function for each observation will depend on whether

retirement occurred in regime 1 (R < a,), regime 2 (a, _ R < a2), or regime 3 (R ? a2).
For observations where no retirement was observed, the likelihood function will depend

on whether the age at last interview, L, occurred in regime 1, 2, or 3. For retirements

occurring in regime 1, the likelihood function is identical to the one outlined in Section
I. The relevant benefit formula is the one in effect prior to 1969 when no benefit hikes
had been enacted or were anticipated. The relevant constraint in Figure 3 is ABLMNP.

For retirements occurring in regime 2, the benefit hike enacted at age a, must be
taken into account. The lifetime constraint in this case is ABCDEQS. Because the worker

did not anticipate the budget-line shift at age a,, the limiting utility-maximum age along

budget segment AB is a, rather than some lower age.10 Casual inspection of Figure 3
might suggest that no worker facing the constraint ABCDEQS should plan to retire just

before a,, since point B is a nonconvex kink. This would indeed be the case if the
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nonconvexity arose intrinsically from the social security formula. For example, if social

security provided a bonus of $10,000 to each worker who retires after attaining age 60
no worker would plan to retire in the month or so before his 60th birthday. However,
because workers anticipated facing the local constraint ABL rather than ABCD, point B

is a possible global maximum on segment AB. This fact must be reflected in computing

the limits to integration, ,l and 1k=i, in the likelihood function equations (7) through

In addition, for workers retiring in regime 2 it must obviously be the case that
retirement did not occur during regime 1. Any combinations of , and E associated with
retirement during regime 1 must therefore be excluded in computing the likelihood of

retiring at age R, al ' R ? a2. Let R* + E < a, designate the combinations of ,3 and E
associated with retirement prior to age a, under regime 1 (i.e. with the constraint
ABLMNP) and R* +E = R denote the combinations of ,3 and E associated with
retirement at age R under regime 2. For al-' R < a2, the probability of R is

Prob (R*+ E- a, R* +E = R).

If no retirement age is observed, and the age at last interview, L, occurs during regime
2, the likelihood of the observation is

Prob (R* + E8- a, r R*, + E > L).

Similarly, let R* +E <a2 denote combinations of ,3 and E associated with retirement

before the end of regime 2 and R*, + E = R represent combinations of ,3 and E associated
with retirement at age R under regime 3 (i.e. with the constraint ABCDEFGH). Then
for R - a2 the probability of observing R is

Prob (R* + E- a, R*, R +8 Ea2nR* R +E=R).

For nonretirees with L - a2, the probability of the observation is

Prob (R* +8E a, r R*, +8 Ea2 r R*,, +E> L).

Using I, II, and III as subscripts to designate the regime during which a particular

observation retired, the likelihood of the entire sample is then

L(t) = HlRetireesj Prob (R* + 8 = R) X HlNonretireesj Prob (R* + E > L)

x HlRetirees,, Prob (R* + E 8 a, r- R* + E = R)

X HlNonretirees ,Prob (R* + E ' a, u R* + E > L)

XH fRetirees..i Prob (R* + E > a, r R* + E i a2r) R* I + R)

x H1Nonretireesjjj Prob (R* + E ' a1 r- R* + E ? a2 - R*I + E > L). (13)

The likelihood function could be extended to take account of an arbitrarily large number

of linear budget segments or benefit increases. It could also be extended to cover the
case of unexpected changes in individual wage rates, but such an extension would be
problematical because the exact age of an unanticipated wage change is virtually imposs-

ible to identify. The next section gives results from maximization of the likelihood function


The estimates reported in this paper are based upon information gathered in the Social

Security Administration's Retirement History Survey (RHS). This survey provides data

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on a longitudinal panel of 8131 families which were headed in 1969 by a male aged 58
to 63. The men were interviewed biannually for the duration of the 10-year project or
until the respondent died, was institutionalized, or otherwise left the sample (see Irelan

(1976)). The most important variables for the analysis are annual wages rates, potential

social security and pension benefits, assets, and retirement age. The exact definition of
retirement age follows the general definition given earlier, namely, a discontinuous drop
in annual work effort. For most men there is a clear age at which labour supply drops
below an average of 30 hours per week. For workers who are involuntarily unemployed
or work an indeterminate number of hours during a particular interview, information

from the immediately preceding and succeeding interviews is used to resolve the ambiguity
about retirement status. In cases where a retiree later returns to full-time work, I use the
first drop in labour supply as the best indicator of retirement. In most cases where
retirement has otcurred, the RHS contains enough information to determine the exact

age at retirement (in years and months). For remaining cases, an excellent approximation
of that age can be derived on the basis of earnings histories.

The RHS contains unusually detailed assets information. Its accuracy is debatable,

however, given problems with recall and valuation of real assets. The ideal measure of
wealth for this paper would include assets held at some early age in the retirement process,

say age 45 or 50.11 No such data are available in the RHS, which includes information
starting only in 1969 (at age 58 to 63, depending on the respondent). Rather than rely

on an imputation procedure of unknown accuracy, I used assets reports for 1969 to obtain
a measure of total family wealth. The respondents were divided into several wealth

categories, originally selected to roughly correspond to quartiles in the wealth distribution

of each birth-year cohort.12 Instead of including this measure of wealth in the intercept
terms (n in equations 4 and 6), dummy variables representing the wealth categories were
included as independent regressors, that is, in Z. This permits wealth holdings to have

a nonlinear effect on retirement age. Only three wealth categories were found to be

associated with significant differences in retirement patterns: (1) no reported assets; (2)
assets worth between $1 and $25,000; and (3) assets worth over $25,000 (1969 wealth is
measured in 1967 dollars). The present discounted value of private pensions was added

to other wealth holdings to arrive at a value of total wealth in 1969.13 When better data
become available, it will be possible to include the budget-line effects of initial wealth
holdings and private pensions in an appropriate way in our measures of n and w. The
limitations of the RHS make that impossible here. For that reason, their effects are

captured in Z, and only wages, taxes, and social security benefits are used in defining n
and w.

Before considering the computation of social security benefits it is useful to discuss

the derivation of potential annual wages. The RHS contains data on hourly wages, usual

weekly hours, annual weeks of work, annual earnings and self-employment income, and
annual social-security-covered earnings for the years 1951-1974. This information is
sufficient to compute not only an average level of earnings but also a rate of growth of
earnings over the later working life. The best estimate of earnings in 1969 can be combined
with a measure of the rate of wage growth to predict potential gross wages in each year

after age 54. In the sample used here, the average rate of growth of real annual wages
remained around 2 5% per year over the entire period examined (1968-1978). There was
no evidence that the rate of growth in particular calendar years differed systematically
in the six birth-year cohorts, as might be anticipated if older workers received smaller

wage increases than younger ones. Hence, most of the rise was due to generally rising
real wage levels. Naturally, there was a great deal of variation in the wage growth enjoyed

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by individual workers. Much of this is attributable to random factors such as excess

overtime, temporary layoff, short hours, temporary surges in self-employment income, or
simple reporting or recording error. Rather than determine or impute an individual
specific rate of wage growth, which might be quite sensitive to temporary factors and
measurement error, I assigned a uniform rate of expected wage growth to workers in the
sample. As mentioned at the end of the previous section, it would be a straightforward
though costly extension to impute individual-specific and even age-specific rates of growth

for each worker. To keep the exposition and estimation reasonably simple, that extension
is not undertaken here. Although the present procedure could be improved, it simplifies
the interpretation of results reported below. All workers are assumed to face a constraint
determined by a common rate of wage growth, with the base level of wages differing
across workers. In determining the net return from an added year of work, income and
social security taxes were also taken into account.14
Social security benefits were calculated using the earnings history records available
in the RHS file as well as the potential earnings imputation discussed above. Benefits
are also computed for the spouse if one is present. Benefits were computed under three
basic formulas, the one in effect before 1970, another in effect 1970-1972, and the last in
effect after 1972. I computed benefits under each of the formulas at three-year intervals
starting at age 56 (that is, at ages 56, 59, 62, 65, and 68). The lifetime constraint is very
close to linear (assuming a zero discount rate) before age 62, after age 65, and between
those two critical ages. In addition, benefits were computed for the two months (in 1969
and 1972) when benefits were significantly raised.15 The lifetime budget constraint under
each of the social security formulas is then computed on the basis of equation (5). Income
received at age 72 and in later years is assumed to be valued at rate 0 in comparison to
income received at ages 54 through 71 (by implication T1 = 71). This division is obviously

somewhat arbitrary, so I also experimented with another value of TI, though the results
were not appreciably affected. The survival probabilities, sa, are taken from the 1969
Vital Statistics.

In addition to the asset variables already mentioned, three other variables were
included to help explain the distribution of retirement ages. The first of these, Bad Health,
takes the value one for men who describe their health as worse than average among

people their age. The second, Married, takes the value one for men who are married
with a spouse present in 1969. The last, HH Size, indicates the number of persons residing
in the respondent's household. (Other variables, reflecting the respondent's educational
attainment, ownership of a home, and vesting in a pension plan, were tried but found to
be poor predictors of retirement age in this model.)
The RHS subsample used here excludes farmers and men reporting substantial
income from welfare programs (such as Old Age Assistance or SSI), federal civil service
pensions, and railroad retirement benefits. These men are not included because a substantial fraction of their expected retirement income cannot be treated in the model without
additional information. For example, federal pensions and railroad retirement benefits
affect the lifetime constraint in the same way as social security. But the RHS does not
contain enough information to calculate the rate at which these benefits are accumulated
at different ages. Men are also excluded from the sample if they were too severely
handicapped in 1969 to work in the past year or if they retired before age 54. Finally,
some observations are excluded for inconsistent or missing data for one or more of the

main variables of interest. These exclusions leave a sample of 4193 observations out of
men originally included in the RHS. Although it would be desirable to increase the
fraction of RHS observations included in the final estimation sample, this cannot be done

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without using some imputed variables for most of the excluded observations. Within the
context of the present model, the required statistical imputation procedure would be quite
burdensome. The results reported below should be interpreted in light of the sample
restrictions just mentioned.

Before turning to results, it is useful to consider the distribution of retirement ages

and social security benefits in the sample. Figure 4 shows the frequency distribution of
retirement ages among observations where retirement had occurred by the last interview
date. As expected, there is a pronounced spike in the distribution at age 65. This spike

Number of men

400 _


300 -

250 -











Retirement age

Frequency distribution of retirement age in estimation samplea

a Nonretirees are excluded.

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is a natural consequence of the nonlinearity in social security benefits at that age. On

average, under the benefit formula in effect before 1969, lifetime benefits (including
benefits received both before and after age 72) rise by $807 per year before, but by only
$536 per year if retirement is postponed after 65. There is a less pronounced spike in
the retirement distribution around age 62, the earliest age at which social security
retirement benefits can be collected. The spike occurs despite the fact that lifetime social

security benefits for most workers actually rise faster between ages 62 and 65 than between
ages 59 and 62. (The rise in lifetime benefits is on average $807 per year between 62 and

65 versus only $725 per year between 59 and 62.) Retirement at age 62 would only make
sense if benefits received later in life are discounted in comparison to benefits received
in the near term. Appendix B provides information on the average tradeoff between

lifetime income and retirement at various ages. RHS respondents were about 58 to 63
years old when the 1969 benefit increase was enacted and about 61 to 66 years old when

the 1972 increase was passed. Thus, benefits were about 20% higher for the youngest

cohort than for the oldest cohort when workers attained the age of 62.
Maximum likelihood parameter estimates are listed in Table I. For computational

convenience, the values of n', n2, w', and w2 were divided by 12 before estimation was
performed. Starting values for all parameters except 0 and o-p were obtained using OLS
estimates of (6) and an ad hoc averaging procedure to obtain instruments for n and w.
Maximization of the likelihood function (13) was accomplished using the procedure

suggested by Berndt, Hall, Hall, and Hausman (1974), and convergence to the maximum
was rapid starting from a variety of initial values. All parameter estimates are highly
statistically significant.


Estimates of retirement age modela

Parameter or variable Parameter estimate standard error









Wealth > $25,000 -1-102 0 130
a, Coefficient on ln (w) 1-317 0 075

1,B Value of coefficient on ln (n) -0 856 0-069

0, discounting factor for income received after age 71 0-464 0-041

oal, Standard deviation of taste parameter 1B 0-483 0 006

o_, Standard deviation of E 0 058 0 003





Source: Author's tabulations of Retirement History Survey file.

a Value of likelihood function = -8801-5. No. of observations = 4193; number of observations with observed
retirement age = 3381; number of observations without observed retirement age = 812.

The estimated effects of the variables included in Z seem reasonable. The effect of

bad health is to reduce the age of retirement, as expected. Men reporting worse health
than average retire 1 1 years earlier than men reporting average or above average health.

Married men retire on average about one-half year later than single men, but the retirement

age seems to have a slight inverse relationship with household size (HH Size). The

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relationship between wealth holdings and retirement age is non-linear. Men with higher

than average family wealth (wealth > $25,000) retire 1 - 1 years earlier than men with asset
holdings between $1 and $25,000. About 5% of the sample reports owning no assets,
and men in this group retire about 0-6 years earlier than men with wealth valued between
$1 and $25,000.
The parameters most relevant to social security are a, ,3, and 0. Interpretation of

these parameters is aided by reference to equation (6) above. Consider a strictly linear

lifetime budget constraint in which w' = 5000, w2 = 675, n' = 18,500, and n2 = 7000. (These
values are selected because they are close to the mean values across the sample for the

budget segments between ages 54 and 70.) The estimated value of 0 is 0-464, indicating
that money received after age 72 is worth only 46% the value assigned to money received

before 72.16 This is equivalent to a discount rate on future income of slightly more than
5%. Given this value of 0, we can now compute n and w. The parameter a is the

coefficient on the natural logarithm of the price of retirement, w. Its value in the sample
indicates a moderate degree of responsiveness to increases in the slope of the lifetime

budget constraint. For example, the estmate implies that if w were doubled (from $5313/12

to $10,626/12) the retirement age would rise by 0-91 years. If w were cut in half, the
retirement age would fall by the same amount.

The estimate of ,3 is somewhat lower, indicating that on average men in the sample
are not as responsive to proportional increases in lifetime wealth. If the average n in the

sample were doubled (from about $21,750/12 to $43,500/12) the average age at retirement
would decline by 0-59 years; if n were cut in half, the average retirement age would rise
by the same amount. The specification of the model includes a normal distribution in

the taste parameter ,3 around its mean value, ,3. The estimated standard deviation of the
,3 distribution, o-1s, is 0-483 or roughly half the value of ,3. This standard deviation is
estimated very precisely, implying that variation of tastes in the sample constitutes an
important explanation for the distribution in retirement ages. A worker with a value of

,3 that is one standard deviation below the mean, for example, would retire 3-62 years
earlier than average. Note that only an extremely small proportion of the sample (less
than 4%) is found to have a positive value of ,3. Increases in n are thus associated with
decreases in the retirement age for the overwhelming majority of the population, as

The parameter a-6 is the standard deviation of the random error term e. Its estimated
value, although very precisely measured, is quite small. A worker with an e one standard
deviation below average would retire only 0-06 years earlier than planned. Recall that e
is introduced to capture the effects of unexpected events, such as layoffs or sudden
deterioration in health, that interfere with retirement plans. Apparently, this source of
random variation is much less important than the distribution of the taste parameter ,3

in explaining retirement patterns. The correlation coefficient, p1,, is significant and

negative. This finding suggests, as anticipated, that workers with higher-than-average
planned retirement ages are more likely to be compelled to retire earlier than planned
because of unforeseen events.

The basic effects of social security on retirement can be outlined briefly. The estimates

of a and ,3 imply that social security increases will have a modest impact on retirement
ages. Variations in the slope and intercept of lifetime budget constraints caused by social
security are associated with statistically significant but small overall effects on the planned
age at retirement. However, at ages 62 and 65 the effects of the program on retirement

are more pronounced. The estimate 0 = 0-464 implies that the lifetime constraint is convex.
The convexity at age 65, caused principally by social security, is especially pronounced.

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At that age the rate of growth in lifetime income, w1 + Ow2, falls from $5627 to $4402 per
year in regime 1 (see Appendix B). This fall in w and associated rise in n at age 65 will
cause a piling up of retirements around that age, because 65 is the planned age of

retirement for persons with a variety of values of the taste parameter X3. At the estimated
value of 0, age 62 also represents a convex kink point for most men, and it will be the
preferred age of retirement for a number of men. Since the decline in w is smaller at 62

than at 65, the (local) peak in the retirement distribution should be smaller at the earlier
age, given the estimated distribution of ,3 in the sample. In the next section I briefly
consider the detailed effects of the 1969 and 1972 benefit increases and provide more
precise estimates of the effect of varying the social security formula.


The social security benefit increases voted in 1969 and 1972 substantially raised the
retirement income expected by men in the RHS sample. However, benefits were boosted

too late for the increases in lifetime wealth to have much effect on the retirement patterns

of men who were on the verge of retirement. There are two interesting questions about
the benefit hikes. How did they influence retirement patterns after 1969? How would

they have affected retirements if they had been enacted before workers began planning
their retirements? To answer the first question it is necessary to compare workers' actual
behaviour after 1969 with what their behaviour would have been if the social security

formula remained unchanged. To answer the latter question' we must compare workers'
potential behaviour if benefits had been raised early in their working lives to what it
would have been if benefits had remained constant.
The answers to both these questions can be obtained in a straightforward way using

the statistical results reported in the previous section.'7 Workers in the RHS estimation
sample are simply assigned the lifetime budget constraints corresponding to each of the
assumptions described above. Their responses to each of the constraints are then determined through statistical simulation. The procedure used here is to -select two random

variates from the bivariate normal distribution defined by 3 - N(-0.856, 0483), E -

N(0, 0.058), and pe = -0-368, and then compute the exact retirement age implied by
this pair of variates as well as the parameter estimates reported in Table I and the two
lifetime budget constraints being compared. To increase the precision of the simulation,

a larger number of (1B, e) pairs can be selected for each observation. (In the simulations
reported below, I selected 20 pairs of random variates for each observation.)
The simulation results are presented in Table II. Figures in the top row of the table
show the simulated retirement distribution under the assumption that the social security

formula remained essentially fixed in real terms over the entire period from 1955 to 1979.
The second row shows the effects of implementing a 10% benefit hike in 1970, but
neglecting to enact the additional 10% hike voted in 1972. The short-run effect of this

benefit increase is to reduce the average retirement age in the RHS estimation sample by

only 0-06 years. Had the benefit increase been in effect from a much earlier year, say
from 1955, the effect on the retirement age distribution would have been somewhat larger,
as shown in the third row. The long-run impact of a 10% increase above the pre-1969

formula is to reduce the average age at retirement by 0-08 years (from 64-53 years of age
to 64 45). This suggests that only about three-quarters of the expected long-run effect of
raising benefits in 1969 could be observed in the birth year cohorts enrolled in the RHS.
The fourth and fifth rows in Table II show the short- and long-run effects, respectively,
of raising benefits in 1972. The fourth row corresponds to the actual situation faced by

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Predicted effects on retirement age of 1969 and 1972 social security increases

Probability of
retiring by:

Social security benefit formula Age 62 Age 65 retirement age

Pre-1969 formula (Regime 1) 0-223 0 570 64-533
1970-72 formula (Regime 2)
Post-1972 formula (Regime 3)









Short-runa 0-228
Long-runb 0 240





Source: Same as Table 1

a Retirement age distribution if benefits are unexpectedly raised in 1969 (Regime 2) or in both 1969 and 1972
(Regime 3).

b Retirement age distribution if 1969 benefit increase had been in effect entire work life (Regime 2) or if both
1969 and 1972 benefit increases had been in effect entire work life (Regime 3).

workers in the RHS sample. A real benefit increase of about 10% was implemented in
1970 and another 10% increase was voted in late 1972. The average retirement age under

this scenario is 0 03 years earlier than it would have been if benefits had not been raised
in 1972 and is 0-09 years earlier than if benefits had not been raised in either 1969 or

1972. The long-run effect of raising real benefits above their 1969 level by 20% can be
determined by comparing the top and bottom rows in Table II. My estimates indicate

that the long-run effect of this increase is to reduce the retirement age by 0 17 years and

to raise the likelihood of retirement at ages 62 and 65 by about 2 percentage points. Only
about half of this long-run effect was actually observed in the RHS cohorts because many
men had already retired by the time the benefit increases were enacted.

My estimates can be compared to those obtained by Hausman and Wise (1985) in

a study based on the hazard model. These authors used the same data set as that used
here, although their statistical treatment of the data is radically different. In spite of the
differences, there is a close similarity between the two sets of estimates of implied short-run
response to the 1969-1973 changes in social security. Hausman and Wise's results can

be used to infer the unconditional probability of retirement at ages 62, 64, and 66 under

the pre-1969 and the actual social security formulas. (The authors report conditional

probabilities at those ages for men who worked at age 60.) Under one of their two
specifications, they estimate that the probability of retirement rose by a trivial amount at
age 62, 1 2 percentage points at age 64, and 2-5 points at age 66. Under their other

specification, the retirement probability rose by 0-2 points at age 62, 1-7 points at age 64,

and 3-0 points at age 66. These estimates are obviously quite close on average to my
predictions of 0.5 points at age 62 and 1-5 points at age 65, though the age pattern of
effects is somewhat different.

Although the retirement effect implied by my simulations (and those of Hausman

and Wise) is not inconsequential, it represents only a small fraction of the decline in

labour force participation that took place during the 1970's. Strictly speaking, our results
pertain only to the effect of social security on retirement, not on labour force participation.
Rising benefits also probably caused a small reduction in employment after retirement,

that is in partial retirement (see Burtless and Moffitt (1984)). Nonetheless, according to
the behavioural estimates reported in this paper, the main explanation for the rapid

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decline in employment of older males must lie elsewhere. The 1969-1972 social security
increases contributed only modestly to the acceleration of an historical trend that had
begun many years earlier.


In this paper I have developed and estimated a model that attempts to explain the
distribution of retirement ages among older men. In broad outline the model is simply
an application of the economic theory of consumer choice. An important contribution

of the paper is to propose and estimate a retirement model in light of the very complicated
choice problem facing potential retirees. The dependence of the "price" of retirement
on the actual amount of retirement consumed causes a significant problem for estimation

that has only rarely been recognized in the existing literature on retirement. Moreover,
social security benefit hikes compound the estimation problem. The econometric model
used here takes these complications fully into account. Social security is found to have

a precisely measured but small overall effect on retirement. If these estimates are
approximately accurate, rising social security benefits in the 1970s played only a small

role in the decline in the average male retirement age in recent years.18 The labour force
participation rate of older men has declined for various reasons in addition to the increase
in social security payments: rising personal wealth levels, sharply higher unemployment
levels in the period after 1970, and changing attitudes toward work and retirement.

The econometric model estimated in this paper is of course based on a number of

maintained assumptions, and it would be useful to relax them in future research. Given

more complete information, for example, it is possible to take account of financial wealth,
private pensions, and changing earnings opportunities in a better way than was done
here. The model depends on the assumption that workers react equivalently to wages

and social security benefits received in the same year in determining their planned
retirement age. This assumption can be relaxed by permitting the two forms of income
to have unequal weights in the utility function. Workers are also implicitly assumed to
respond instantaneously to announced benefit hikes in determining the optimal age of

retirement. Since workers might not become aware of the benefit increase for several

months (or even years), it seems worthwhile to test the effect of some alternative assumptions. Finally, it is highly desirable to embed the retirement decision in a complete model

of lifetime labour supply and savings. Actual estimation of such a model, however,
depends on development of much better data than that currently available.
The extensions just mentioned could provide important insights into the retirement

process. But there is no reason to feel undue pessimism about our current state of
knowledge. When the Congress and President boosted social security payments in 1969
and again in 1972 they provided economists with a rare laboratory experiment with which

to examine the effect of a major program change on economic behaviour. By happy

coincidence, the U.S. government had launched major panel surveys of the affected

population shortly before the first benefit increase was announced. Although it is true
that benefits were raised by the same percentage amount for all prospective retirees, the
benefit increases had quite different implications for individuals at different ages. In the

sample used here, real benefits at age 62 were 20% higher for workers in the youngest

cohort than for workers in the oldest. Otherwise identical men, separated in age by only
five or six years, faced considerable differences in the incentive to retire as they approached

their retirement years. From a statistical point of view, the benefit hikes introduce a great
deal of random variation in the lifetime budget constraints facing the sample. If the

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social security increases greatly complicate the procedures required for empirical estimatlon, they also permit us to be unusually confident in drawing conclusions about the
effects of program reforms.


Social Security Benefit Levels, 1955-1977

The historical trend of the social security benefit formula is shown in Figure 5. The
diagram shows the real social security payment of a retiree with a fixed earnings history
in each year from 1955 through 1977 as a fraction of the real benefit paid to a 1966 retiree

with the same nominal wage history. Real benefits rise in the year immediately following

a benefit increase (1954, 1958, 1965, and 1967), and then decline gradually as a result of
price inflation. There were four cycles of rising then declining real benefits between 1954

and 1969, but there was no overall trend in real benefit levels. This does not imply that
average real benefits paid to new retirees remained constant between 1955 and 1969. In

fact, the average primary insurance amount rose in real terms by about 20% over that
period. This rise was due, however, to the maturation of the system and to the fact that
lifetime wages of 1969 retirees were higher than those of 1955 retirees. (See Social Security
Bulletin, Annual Statistical Supplement, 1977- 79, p. 111.)





0 90


1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977


Real social security benefit relative to real benefit in 1966a

Source: Social Security Bulletin, Annual Statistical Supplement, 1977-1979, U.S. GPO, p. 26.
a The benefit in 1972 covers payments through September 1972 and does not reflect the benefit increase voted
in that year and effective in September.

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After 1969, real benefits were raised substantially as a result of legislation passed in

1969, 1971, 1972, and 1973. As described in the paper, benefits were generally about
10% higher in 1970-1972 than they had been over the period 1955-1969, and they were

about 20% higher after 1972 than they had been between 1955 and 1969.


Average Slopes and Intercepts of Lifetime Budget Constraints in RHS Sample

Table III provides information for the RHS estimation sample on the average tradeoff

between lifetime income and retirement at various ages. The table contains three panels,

each one showing the intercepts and slopes of four budget segments under a particular
social security benefit regime. The top panel shows the lifetime constraint under regime
1, that is, the social security formula in effect before 1970. The first two rows in that
panel give the intercepts (measured at age 54) for income received before and after age

71, respectively. The third row shows the rate of rise of income received before age 72,

and the fourth row shows the rate of rise (or decline) of social security benefits received
before age 72. The fifth row gives the rate of rise of income received after age 72. (Since
private pensions are not included here, all of this rise is due to changes in social security

benefits.) The second and third panels give the same information for budget constraints
under benefit regimes 2 and 3, respectively, that is, budget constraints under the 1970-1972

and post- 1972 social security benefit formulas. The difference between n' + n2 in the top
panel and the n'+ n2 in the second panel represents the gain in lifetime social security
benefits due to the real benefit increase enacted in 1969. The same difference for panels
2 and 3 shows the gain due to the benefit increase passed in 1972.
The relative convexity of the budget constraints defined in each of the three panels

depends critically on the value of 0, the discounting factor applied to n2 and w2. The
k-th kink point is convex if the slope of the lower budget segment is greater than that of

Average intercepts and slopes of budget segmenta










Pre-1969 Benefit Formula


























1970-72 Benefit Formula

nl 11,712 11,660 16,257 26,622
















Benefit Formula after 1972


























Source: Author's tabulations of Retirement History Survey file.

a Figures measured in 1967 dollars. For explanation of notation, see text.

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the next higher segment, that is, if Wk Wk+1 or (wl+ Wk)_(wV1+ * w+ 1). Thus if
0= 1, the budget lines are nonconvex at age 62.
First version received October 1984; final version accepted March 1986 (eds.).

The research reported here was supported by the U.S. Department of Health and Human Services through
a grant to the Brookings Institution. I gratefully acknowledge the research assistance of Harold Appelman and
Alice Keck and the helpful suggestions of Robert H. Meyer, Robert A. Moffitt, Joseph P. Fennell and Paul E.
Morawski. Grayham Mizon and two anonymous referees also provided exceptionally useful comments.
Remaining errors are of course my own responsibility. All opinions expressed herein are those of the author
and do not necessarily represent those of Brookings or the Department of Health and Human Services.

1. Employment and Training Report of the President, 1982, Table A-5.

2. Age 54 is used in this paper because the sample is restricted to men who retire at age 54 or later.
3. Between ages 62 and 65 the actuarial adjustment factor is approximately 8% per year of benefit delay,
which is close to actuarially fair for an unmarried male. During the period examined in this paper, the actuarial
factor after 65 was 1% per year, which is far less than actuarially fair. Since that time it has been raised to
3% per year, and it will be raised again under legislation passed in 1983.
4. Burtless and Moffitt (forthcoming) show that workers' inability to borrow against future social security
benefits may provide another reason that some individuals are induced to retire at age 62, which is the earliest
age at which social security benefits can be used to finance current consumption.
5. The price of retirement is therefore computed by assuming that workers fully retire. Given the low
earnings of partial retirees and the short duration of partial retirement, this assumption appears warranted.
Recent studies of partial retirement include Gustman and Steinmeier (1983) and Burtless and Moffitt (1984).
6. The definition of w implies that it is the partial derivative of lifetime income with respect to retirement
age. In preliminary work I also tried the constant elasticity demand specification, used in Burtless and Hausman

(1978), and the linear demand function, used in Hausman (1981). In both cases the likelihood functions failed
to provide stable estimates of the unknown parameters. More precisely, the likelihood functions could not
produce finite estimates of one or more of the parameters. The strong implication is that the underlying
specification of preferences in these two alternative demand functions did not provide useful approximations
to retirement preferences in the sample.
7. The procedure applied here is more cumbersome, but more general, than that originally proposed in
Burtless and Hausman (1978). The complication arises because the indirect utility function implying (6) cannot
be analytically determined. Burtless and Hausman and later Hausman (1981) derived closed form utility
functions for the demand functions they estimated. Such closed form solutions do not always exist.
8. The passage of Medicare in 1965 also caused a major rise in real transfers to the elderly. For several
reasons, however, it does not seem appropriate to treat enactment of the health insurance program in the same
way one would treat an increase in cash benefits. First, unlike the benefit increases in 1969 and 1972 the

Medicare program had been widely anticipated for several years. Second, the benefits conferred by Medicare
are different in nature than simple cash payments since they are specifically restricted to one form of consumption-hospitalization and physician services. Finally, RHS sample members were aged 54 to 59 at the time
Medicare was passed, relatively early in their retirement planning period.
9. Moffitt (1984) has pointed out that unexpected increases in social security benefits imply that some
workers may have oversaved for their retirement. Since their savings are above the level that would be optimal
had the benefit increase been accurately anticipated, these workers may retire earlier than they would if the
increase had been foreseen. I ignore this possibility here because the model does not attempt the joint explanation
of savings and retirement age.

10. The limiting ages were denoted above as a, and aj in the case of linear segments and as ak in the

case of convex kink points. See discussion of equations (7) through (10) above.

11. Both wealth and retirement age are obviously jointly determined in a completely specified retirement
or savings model. This cannot be done here because the requisite data on wealth accumulation over the lifetime
do not exist. The results reported below should be interpreted with this caveat in mind.
12. Surprisingly, there were only trivial differences in the wealth distributions of respondents in the six

age categories (ages 58, 59, 60, 61, 62, and 63). Consequently, no adjustment was made for a respondent's age
in computing the wealth category to which he was assigned.
13. In theory private pensions introduce a nonlinearity in the tradeoff between lifetime income and
retirement age and should be treated analogously to social security. See, for example, Burtless and Hausman

(1982) and Fields and Mitchell (1984). However, RHS data on private pensions are not detailed enough for
this kind of statistical treatment. In addition, it should be noted that while private pensions may induce workers
to leave particular jobs at given ages, they do not usually require workers to leave paid work altogether, as
social security does, if a pension is to be collected.

14. The federal tax formula and FICA tax rate changed frequently in the 1960's and 1970's. The average
tax rate on wage earnings was estimated by using the average tax liability that would have been owed on

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earnings received between 1967 and 1971. The income tax liability on wages was computed using the standard
deduction and taking account of taxable unearned income.
15. The resulting approximations to the lifetime constraint contain up to four linear segments and three
kinks for retirees in regime 1, five segments and four kinks for retirees in regime 2, and six segments and five
kinks for retirees in regime 3. The first segment is assumed to begin at an indefinitely early age and the last
segment to end at an indefinitely high age.

16. This estimate of 6 depends on the specific division of the life span into two periods (see the discussion
of equation (5) above). I obtained an estimate of 6 using a different choice of T1 and found other coefficients
very similar to those reported in Table I. In particular, the estimated value of income received after age 65
was within 1% of the value implied by the estimate of 6 reported in Table I. None of the other coefficients
moved by as much as one standard error, and the great majority were virtually unchanged.

17. The estimates of long-run effects require that we maintain our assumption that private wealth
accumulation is unaffected by the level of social security wealth. This remains a controversial issue in the

economics profession. See Aaron (1982), pp. 40-52.

18. This is a conclusion also reached by Moffitt (1984) in a careful time-series analysis of aggregate labour
supply trends over the post-war period.

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