The Long-Term Benet of Lowering the Retirement Age

Mike Isaacson Howard University michael.s.isaacson@gmail.com November 30, 2011

Abstract

I.

Introduction

In December of 2010, Bolivian President Evo Morales announced the decrease in the age of eligibility for retirement benets from 65 for men and 60 for women to 58 universally.1 This move was largely political, since the deal was also packaged with a law that renationalized the pension system that had been privatized in 1996.2 This bucks the trend of talks of spending cuts and austerity measures taking place in most European nations as well as a partisan stando in the United States leading to that end. During the 2010 midterm elections, there began a reprise of the mid-2000s discussion of privatizing Social Security in the United States.3 It became in vogue for Republican candidates to praise former Chilean dictator Augusto Pinochet in his privatization of that country's public pension plan.4 Though proposals dier in their approach, by and large, they all would have public retirement funds invested in the stock and bond markets.5 Given the uctuations in nancial markets, and the recent fate of many private dened contribution plans,6 it would seem that such proposals would be at best unstable and at worst unsustainable. Given the history of
This paper was typeset using the T Xworks compiler and the MiKT X typesetting system E E

1 Associated 2 Turner,

Press, The. Bolivia Drops Retirement Age to 58.

2011. <http://www.businessweek.com/ap/nancialnews/D9JSH7K80.htm> Taos. Bolivia Passes Bill to Nationalize Pension Systems. The. The Revolution Comes Home.

cessed: 25 Nov 2011. <http://online.wsj.com/article/SB10001424052748 703350104575652852902005086.html>

3 Economist,

<http://www.economist.com/node/3559860>

4 Garcia,

Oskar.

Angle on Private Social Security: Chile's Done It.

Accessed: 25 Nov 2011. <http://www.omaha.com/article/20100813/AP06/308139843>

5 Shipman,

William. How Individual Social Security Accounts Would Work. Jock. Dened Pension Plans Threatened by Lower Returns.

Accessed: 25 Nov. 2011. <http://www.cato.org/pub_display.php?pub_id=3326>

6 Finlayson,

2011 Accessed: 25 Nov. 2011. <http://www.vancouversun.com/business/Dened+pension+plans+threatened+ lower+returns/5641322/story.html>

Business Week. Wall Street Journal. The Economist. Omaha World-Herald. CATO Institute. Vancouver Sun, The.

3 Dec 2010 Accessed: 16 Nov 3 Dec. 2010 Ac-

13 Jan 2005 Accessed: 25 Nov 2011. 13 Aug 2010

21 Nov. 2003 1 Nov.

legislative tactics used by the GOP, it would seem that this may be the objective.7 In the lead up to the 2012 election, the GOP doubled down on the regressive retirement policy with Massachusetts governor Mitt Romney vowing to raise the retirement age.8 While this might ease the current strain on the Social Security trust fund, a fund separate from the federal government's general fund which politicians have convinced the American public should be balanced, the question remains about the plan's long-term ability to provide a sustainable public pension system. Given the current shortage of jobs, should we be crowding out a younger, unemployed workforce to cut a part of government spending that doesn't even contribute to the decit politicians have convinced lay Americans that it's a good idea to balance?9 Additionally, do the short term benets of being able to raid the Social Security trust fund10 outweigh the long-term costs in terms of labor productivity and ecient human capital allocation? Further, given a disparity in life expectancy, does this short-term benet justify the dierential impact this increase will have on people of color?11 While GDP is growing, it by and large has nothing to do with additional production. In fact, the growth is largely due to businesses cutting workers in exchange for prots.12 While our economy can grow on paper in this way in the short term, in the long term we will eventually run out of jobs to slash. Ultimately, we need jobs now. During a time of the highest rate of unemployment since the Great Depression, as well as the longest time in a recessionary economic trough, it makes little sense to keep workers in the labor force who would otherwise retire. Further, for every dollar of Social Security benets that we would save from a higher retirement age, we are spending on social insurance programs for those who would otherwise be able to nd employment. Depending on the exchange rate between older and younger workers, this supposed savings may actually turn into a net expense when these factors are accounted for. Rather than increasing the retirement age, this paper proposes a decrease in the eligibility age for Social Security. While this will no doubt put additional strain on the Social Security trust, the hope is that this cost will be oset by relieving stress on welfare rolls for the friction7 Bowman, 8 Beatty, 9 Miller,
Michael.  `Do Nothing' Option for US Decit Reduction Explored.

2011 Accessed: 26 Nov. 2011. <http://www.voanews.com/english/news/usa/Do-Nothing-Option-for-US-DecitReduction-Explored-134459668.html> Andrew. Republican Romney Vows to Raise US Retirement Age. Nov. 2011.

Voice of America.

24 Nov.

<http://www.google.com/hostednews/afp/article/ALeqM5ggyTKBPfY4NSGXopwqzRqzm42Z0w?

AFP

4 Nov. 2011 Accessed: 26

docId=CNG.0aee2506f14c473a807db82f635b1a20.4a1> Mark. Decit Battle Won't Cause Fight Between Old and Young.

26 Nov. 2011. <http://www.reuters.com/article/2011/11/22/usa-debt-generations-idUSN1E7AL0RQ20111122>

Reuters.

22 Nov. 2011 Accessed:

10 Media

Matters for America. Wash. Post Article Repeatedly Misleads On Social Security.

31 Oct. 2011 Accessed: 26 Nov. 2011. <http://mediamatters.org/research/201110310014>

Media Matters.
29 Nov. 2011.

11 Rockeymoore,

People of Color.

12 U.S.

Businesses Bank Record Prots.

<http://www.tampabay.com/incoming/us-businesses-bank-record-prots/1136091>

Commission to Modernize Social Security. St. Petersburg Times.

2

Maya M. and Lui, Meizhu. Plan for a New Future: The Impact of Social Security Reform on Oct. 2011. 24 Nov. 2010 Accessed:

ally unemployed. Additionally, it is hoped that a younger workforce would raise overall labor productivity, leading to higher levels of output, higher incomes, and hence a higher pool from which to collect payroll taxes.

II.

Literature Review

Shortly following the Bolivian pension move as well as a move by France in the opposite direction, economist James K. Galbraith wrote a short piece arguing for decreasing the retirement age from a pragmatic point of view. In it, he undercuts the conventional wisdom that we are living longer. But in the rst place, "we" are not living longer. Wealthier elderly are; the nonwealthy not so much. Raising the retirement age cuts benets for those who can't wait to retire and who often won't live long. Meanwhile, richer people with soft jobs work on: For them, it's an easy call.13 Certainly, we are living longer on average.14 But when life expectancy is broken down by income, the rate of life expectancy increase among the top half of income earners far outpaces those in the bottom brackets to a very noticable degree.15 Further, when broken down by race, the life expectancy for Black folks is consistently lower than their White counterparts.16 Needless to say, life expectancy is lower for folks who are typically less well o nancially and hence more likely to need Social Security retirement benets in old age. Raising the retirement age would thus adversely aect those for whom Social Security was designed in the rst place. This all presumes that the seniors we are talking about have employment in the rst place. Given that older workers face discrimination in employment,17 older workers are more vulnerable to layos in the absense of a strong union and unlikely to nd new employment that pays as well as previous jobs.18 Galbraith, again, frames the problem beautifully: In the United States, the nancial crisis has left the country with 11 million fewer jobs than Americans need now. No matter how aggressive the policy, we are not going
13 Galbraith, James K. Actually, The Retirement Age Is Too High. 14 National Center for Health Statistics. Health, United States, 2010:
Dying.

of Age, and at 75 Years of Age, by Race and Sex: United States, Selected Years 1900-2007.

Department of Health and Human Services.

Health Statistics, et al.

Foreign Policy.

184 (2011): 72.

With Special Feature on Death and

Feb. 2011: Table 22. Life Expectancy at Birth, at 65 Years

15 Waldron,

Hilary. Trends in Mortality Dierentials and Life Expectancy for Male Social Security-Covered

Workers, by Average Relative Earnings. 108 (2007).

16 National Center for 17 Bendick Jr., Marc, 18 Shapiro,

Against Older Workers.

Economic Journal.

David and Sandell, Steven H. Age Discrimination in Wages and Displaced Older Men. 52 (1985): 90-102.

U.S. Social Security Administration, Oce of Policy. op. cit. Journal of Aging & Social Policy.
10 (1999): 5-23.

Working Paper

No Foot in the Door: An Experimental Study of Employment Discrimination

Southern

to nd 11 million new jobs soon. So common sense suggests we should make some decisions about who should have the rst crack: older people, who have already worked three or four decades at hard jobs? Or younger people, many just out of school, with fresh skills and ambitions?19 While the current jobs crisis appears to be nothing but what The
Daily Show's

Jon Stewart

would refer to as a `clusterfuck,' it also provides us with a unique opportunity. In a study of Canada's economy from 1981-2001, Tang and MacLeod found that the aging population of Canada, whose demographic structure is similar to the United States in terms of a baby boom, has and will continue to decrease overall productivity throughout the rst decade of this century.20 Given the recent recession and the aect it has had on pensions, their projection would likely have to have a longer horizon of decreased productivity. Microeconomically, Kotliko and Gokhale veried the age-productivity relationship in a case study of a Fortune 1000 rm. In their research, they concluded that productivity falls with age, such that younger workers are often undercompensated in wages and older workers overcompensated.21 This would imply that lowering the retirement age would give us more bang for our buck. Further, in a case study of poultry plant workers in Georgia, Harvey and Kagerer concluded that few workers quit for leisure. Not many quit for compensatory reasons, with the primary factor being dissatisfaction with the work environment.22 This would imply that less able workers may be more inclined to leave their place of employment if they knew that there were a social safety net waiting for them. Despite much evidence demonstrating the additional productivity of youth, no study has been conducted to determine the net eect of lowering the retirement age. In this paper, I demonstrate this potential benet.

III.

Theory and Methodology

I begin my analysis with a labor theory of value, such that:

Yt = Lt

(1)

Where Yt is the annual real gross domestic product23 and Lt is the annual value of labor. For

op. cit. Canadian Journal of Economics, The. 21 Quarterly Journal of Economics, The. 22 American Journal of Economics and Sociology. 23 National Income and Product Accounts.
19 Galbraith, James K., 20 Tang, Jianmin and MacLeod,
Carolyn. 39 (2006): 582-603. Kotliko, Laurence J. and Gokhale, Jagadeesh. Present Value of Workers' Earnings. 35 (1976): 137-147. Government of the United States. Analysis.

Labor Force Ageing and Productivity Performance in Canada. Estimating a Firm's Age-Productivity Prole Using the 107 (1992): 1215-1242.

Harvey, Bruce S. and Kagerer, Rudolph L. Marginal Workers and Their Decisions to Work or to Quit. Table 1.1.5 Bureau of Economic

the purpose of this model, we assume heterogeneity in the marginal eectiveness of labor by age. I have decided to disaggregate the labor force in a Cobb-Douglas formulation, such that labor from across the age spectrum has a multiplicative combinatory relationship. This makes sense since experience comes with age, whereas vitality comes with use. Thus, businesses would do well to have some combination of age groups rather than just one:
Yt =
i

Li it

> 0i

(2)

Where i is representative of the age brackets and i is a parameter representing the output elasticity for any age bracket i. We can use logs to collapse equation 2 into a linear formation:
ln Yt =
i

i ln Lit

(3)

From here, it is possible to estimate an OLS equation from existing data, such that the coecients will be output elasticities of labor for their respective age brackets. Unfortunately, there are no age-bracketed added value of labor statistics, since such a statistic would be hard to quantify and likely harder to gather data for. Further, total labor hours (my preferred measure of labor) is not awailable by age group. The only useful variable for which labor hours are broken by age group is total employment.24 Given available data, this is broken down into 5-year increments. Through the course of the analysis, it was reaggregated in the interest of increasing degrees of freedom and reducing multicollinearity into 3 representative groups: 16-34, 35-54, and 55+. This of course presents its own problems as each worker does not necessarily put in the same number of hours each year. Thus, if certain age groups are more prone to part time work, the results may be skewed somewhat. We will return to this concern later. After this comes the fun part. Having estimated the output elasticities of the varying age brackets of labor, we must attempt to estimate how employment would change were the employment rate lowered. Using the monthly civilian labor force participation rates in 5-year age brackets,25 I will impute the labor force participation rates if the retirement age were lowered to 55. I chose to limit the sample to the past two years because of how much the age demographics of the labor force have changed in the past decade. This is shown in gure 1. As the lines grow lighter, the data is closer to the present. Clearly, the labor force has become older over the past
24 Government of the United States.
Bureau of Labor Statistics.

Seasonally Adjusted.

25 Government

of the United States.

Bureau of Labor Statistics.

Employed Population, 1987-2009 by Year by Age, Not Seasonally Adjusted. Civilian Labor Force Participation Rate, 2010-2011 by Month by Age, Not
5

Figure 1 decade. Thus, to provide consistency to the data, I chose only to use data from 2010-2011. From here, I will calculate the laborers from the 55-65 age bracket that would otherwise be retired. Given this information, using the results from the rst regression, I will calculate the resulting increase or decrease in GDP due to the shift in workers. Finally, I will calculate the aect a GDP change has on overall employee compensation26 using a simple linear equation. Given this information, I will then calculate the approximate additional funds that will be contributed to the Social Security and Medicare trust funds per the FICA tax. Further, I will calculate the expected additional strain on the Social Security trust fund from the workers expected to retire as well as the expected additional revenues for the general fund. These adjustments will be analyzed in light of their overall eect on the budget as well as the general benet to the economy. This analysis does not and cannot assess a monetary value to the social welfare gain from a more fully employed population. This would be assumed positive, but hopefully, it will not be necessary to hide behind this cop-out.
26 Government
Analysis. of the United States

National Income and Product Accounts.

Table 2.1.2 Bureau of Economic

IV.

Empirical Analysis

The rst equation I estimated was the one described by equation 3 using the aggregated labor data:

ln GDPt = 0 + <35 EM P<35t + 3554 EM P3554t + >54 EM P>54t + t

(4)

I used data from 1987 to 2009. Given some issues with multicollinearity, I used rst dierences. The results are recorded in table 1. Table 1 Variable
constant ln EM P<35 ln EM P3554 ln EM P>54 R2 R2

Coecient 0.005 0.265 0.740 0.000 30.56** 23

83.59% 80.85%

t-Statistic 0.59 1.23 3.68** 2.12*

F-Statistic
n

* = 5% Signicance ** = 1% Signicance

As we can see, most coecients are statistically signicant. Additionally, the R2 and R2

demonstrate that the model does a good job at explaining the variation in the natural logarithm of GDP. Additionally, the signicance of the F-Statistic indicates that the overall model is signicant. As expected, all of the coecients on the labor values are positive and in between zero and one. Additionally, the middle age range of laborers has the highest output elasticity, again as expected. As expected, the >55 labor pool has the lowest output elasticity Next, using the monthly civilian labor force participation rate data for 2010-2011, I estimated an OLS regression using interaction dummies:

RAT Et = 0 + <35 AGEt D<35 + 3554 AGEt D3564 + >54 AGEt D>64 + (5)

Where RAT Et is the civilian labor force participation rate for a given age group in a particular month, AGEt is the lower bound of the age group,27 and the variables Drange take the value
27 This
variable took the values 16, 20, 25, 30, 35, 40, 45, 50, 55, 60, 65, 70, and 75.

one if the AGEt variable is within the bounds of the specied range, and zero otherwise. This allows us to determine the labor force participation rate's sensitivity to age in these three age ranges. The results of this regression are in table 2. Table 2 Variable
constant

< 35 35-64 > 64

F-Statistic
n

R2 R2

Coecient 60.179 0.463 0.291 0.592 267.41** 281

74.33% 74.06%

t-Statistic 12.98** 2.29* 2.98** 8.43**

* = 5% Signicance ** = 1% Signicance

According to the regression, each additional year of age will increase the labor participation rate by 0.46% for those under 35 years of age and by 0.29% for those aged 35-64 years old. Additional years of age will decrease labor force participation by 0.59% for those past retirement age (i.e., those older than 64). In order to predict the labor force participation rate were the retirement age lowered to 55, we simply plug 55 and 60 into the equation as follows:
60.179 0.592 55 = 27.596 60.179 0.592 60 = 24.634

(6a) (6b)

Thus, the civilian labor force participation rates for 55 and 60 year-olds are expected to reduce to 27.596% and 24.634%, respectively. Using these data, we nd that lowering the retirement age would free up 9,499,000 jobs. From here, I assume that businesses will hire new workers from the < 35 years and 35-54 years labor pools in direct proportion to the output elasticities displayed in table 1. Thus, we should expect to see approximately 2,507,000 workers hired from the labor pool younger than 35 and approximately 6,992,000 workers hired from the labor pool in between 35 and 54 years of age. Plugging these values back into the equation estimated in table 1 we can calculate how the new GDP will compare to the old GDP, since taking the antilog of a rst dierence of logs would yield the ratio between the new value and the old one, or 110.06% of last year's value.
GDPt GDPt1

. This ratio was 110.06%,

meaning that the new value of GDP after the mass retirement and labor replacement would be

Calculating from the 2010 level of GDP28 would mean that we should see a GDP level of $14,404,653,000,000. This represents a $1,316,700,000 increase in GDP. From here, I calculated the aect that a GDP increase has on employee compensation. The results are presented in table 3. As we can see, the regression appears to be fairly good. The only area of concern might be that the coecient of determination implies that the model explains only 71.59% of the annual change in employee compensation from its mean, but otherwise the model is very signicant statistically. Table 3 Variable
constant GDP R2 R2

Coecient 85.193 0.591 50.39** 22

71.59% 70.17%

t-Statistic 3.20** 7.10**

F-Statistic
n

* = 5% Signicance ** = 1% Signicance

Using the above estimation, we should expect employee compensation to rise by $863,400,000,000. According to the Tax Foundation's analysis, the average tax rate in 2009 was 11.06%. While this may not be a good projection as both tax structure as well as the income levels have likely changed since 2009, it is the best estimate available.29 Thus, we should expect government revenues from the income tax to increase by $95,500,000,000. Additionally, the additional revenues for the Social Security trusts (FICA and HI) will yield a combined additional revenue of $66,100,000,000 based on the combined rate of 7.65%.30 Based on the average monthly Social Security benet in December 200931 and the number of workers 55-64 expected to retire from the labor force as well as those currently unemployed in that age range (11,073,000 total), the expected additional strain on the Social Security trust in a year should be around $197,200,000,000. Finally, I anticipate that as young folks are hired, some of them will be coming o of government assistance programs. I estimated the change in government social benet transfer payments as a function of change in employment for those under the age of 55. The results are presented in table 4. As we can see, an additional thousand workers will yield a savings of approxi28 Government
nomic Analysis. of the United States. National Income and Product Accounts. Table 1.1.6.1 Bureau of Eco-

29 Logan,

David S. Summary of Latest Federal Individual Income Tax Data. of the United States.

24 Oct. 2011 Accessed: 30 Nov. 2011. <http://www.taxfoundation.org/news/show/250.html>

30 Government

Accessed: 30 Nov. 2011 <http://www.ssa.gov/oact/progdata/taxRates.html>

FICA & SECA Tax Rates.

The Tax Foundation.

Table 1.

Social Security Administration. 29 Dec. 2010

tion.

31 Government

of the United States. Annual Statistical Supplement 2010. 5.B1

Dec. 2009 Accessed: 30 Nov. 2011.

Social Security Administra-

mately $25,000,000. From this we can say that the 9,499,000 new hires will save approximately $239,700,000,000. Table 4 Variable
constant L1654 R2 R2

Coecient 92.100 00.025 106.67** 22

84.21% 83.42%

t-Statistic 19.01** 10.33**

F-Statistic
n

* = 5% Signicance ** = 1% Signicance

If we do the math, we nd that we should save approximately $204,100,000,000 from lowering the retirement age. For the sake of simplicity, I have presented the arithmetic below:
+ +

$95,500,000,000 $66,100,000,000 $239,700,000,000 $197,227,800,000 $204,100,000,000

Income Taxes Social Security Payroll Taxes Transfer Payment Reduction Social Security Payments Total Budget Savings

This savings, combined with the projected decrease in the employment rate,32 represents a net gain for the economy.

V.

Conclusion

Dear Barack Obama, I have analyzed the eect of lowering the eligibility age to collect full Social Security benets. Despite the initial strain such a program will have on the Social Security trust fund, I anticipate that this move should have an overall positive impact on the economy as well as on the government budget. From my analysis, I have concluded that this move will have an overall savings of $204.1 billion. This comes from the combined benets of a younger, more productive workforce as well as from folks coming o of government assistance programs to join the workforce. There is no time to do nothing. The longer the economy remains in limbo, the longer those who are unemployed remain so, the longer that the business community is unsure of government policy, the longer that we expect seniors to work past their prime, the more damage we do to
32 Which,
given the backlash against the failure of the projections around the Obama stimulus, I have declined

to estimate. From the projections given in this paper, this shouldn't be too dicult to calculate.

10

the economy. As we sit and do nothing, other countries will gain more of a competitive edge over US business and the American worker. Mr. President, it is unconsciounable to play the violin as Rome burns. No economy has recovered by doing nothing. It is time for the government to once again do its job: serving the interests of the American people. Sincerely, Michael Isaacson Howard University

11