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In the wake of the government shutdown, the budget conference committee led by House Budget Committee Chairman Paul Ryan, R-Wis., and Senate Budget Committee Chair Patty Murray, D-Wash., now faces the tough and contentious work of trimming the massive federal budget. Entitlement spending will likely be a central issue, and one where both sides agree that something’s got to give: either entitlement spending will need to be cut or taxes must be increased.
But a number of economists have pointed out that there’s a way to make these adjustments a bit less painful. Policymakers can boost income and payroll tax revenue by taking steps to facilitate longer working lives – for example, by changing the structure of Social Security and Medicare so that they stop punishing work at older ages.
Some have objected to such recommendations, arguing that older workers who stay on the job longer make it harder for younger workers to find employment. They see the labor market as a competition between grandma, who’s had years to secure her financial future, and junior, who’s just starting out and is facing bleak job prospects.
But there’s no evidence that older workers threaten the jobs of younger ones. In fact, reducing work disincentives in Social Security and Medicare is likely to boost economic output, reducing the size of the tax increases and entitlement cuts that younger workers will need to face.
For an example of how this works, think back to the expansion of the labor force that occurred when many women started to work outside the home. Why didn’t this shift put large numbers of men out of work or reduce their earnings dramatically? The answer is that when the workforce grows, there are more goods and services to go around. This works out well because the new workers also play a role as consumers, who are looking for ways to spend the wages that they earn. In other words, the size of the pie grows, and a bigger pie can support more jobs.
Research confirms this with regard to older workers. A 2010 study by researchers at MIT and the University of British Columbia found no systematic relationship between Social Security rule changes that altered work incentives at older ages and the employment of young and middle-aged workers. And another – done in 2012 by researchers at the Center for Retirement Research at Boston College – examined state-level data and found no evidence suggesting that increases in the level of elderly employment in a state harm either the employment or earnings of younger workers.
These results suggest that the labor market expands to accommodate older workers who want to extend their careers. It’s this kind of dynamism that has allowed the economy to adapt to the entry of women into the labor force, to high levels of immigration, and to population growth.
But what if the labor market isn’t working as well as it should? Indeed, today’s high unemployment – particularly among youth – may indicate a temporary problem with the dynamic process by which the economy absorbs new workers. In other words, if the pie is shrinking because the economy is weak, then it might not be able to support new workers very well.
It turns out, however, that even in a bad economy, delayed retirements aren’t harmful to younger workers. The 2012 study by the Boston College researchers also examined employment patterns during the recent Great Recession and confirmed there’s no connection between elderly employment and the labor market outcomes of younger workers.
How can policymakers help facilitate longer working lives? Under the current Social Security benefit formula, all workers pay payroll taxes on their earnings. Normally taxes discourage work, but the work disincentive created by the payroll tax is at least partially offset by the fact that working and earning more also brings higher future retirement benefits. Early in a person’s career, retirement benefits rise quite rapidly with additional work; however, for older workers, the additional retirement benefits earned from working more can be quite small. Thus, the payroll tax discourages work more strongly for older workers than younger ones. That’s compounded by the fact that the work decisions of older individuals tend to be quite sensitive to take-home pay. Policymakers can encourage longer careers by restructuring the tax and benefit formula to reduce this work disincentive.
Prolonging working lives won’t make the government’s long run fiscal imbalance go away, but it can make the adjustment process easier by bringing in some new revenue. And policymakers can rest assured that taking steps to encourage longer working lives will help grandma keep contributing to the economy, not prevent junior from starting his own career.
Sita Nataraj Slavov is a resident scholar at the American Enterprise Institute.
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