Working Paper: NBER ID: w29905
Authors: Xiaodong Fan; Ananth Seshadri; Christopher R. Taber
Abstract: We develop and estimate a life-cycle model in which individuals make decisions about consumption, human capital investment, and labor supply and use it to analyze changes in Social Security rules. The most important aspect of our paper is human capital towards the end of the life cycle which responds to changes in the rules. Retirement arises endogenously as part of the labor supply decision. The model allows for both an endogenous wage process through human capital investment (which is typically assumed exogenous in the retirement literature), an endogenous retirement decision (which is typically assumed exogenous in the human capital literature), and accounts for the Social Security system. We estimate the model using indirect inference to match the life-cycle profiles of employment and measured wages from the SIPP data. The model replicates the main features of the data—in particular the large increase in measured wages and small increase in labor supply at the beginning of the life cycle as well as the small decrease in measured wages but large decrease in labor supply at the end of the life cycle. We use the model to estimate the effects of various changes to tax and Social Security policies and show that allowing for human capital accumulation is critical.
Keywords: lifecycle model; human capital; labor supply; retirement; social security
JEL Codes: J22; J24; J26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in social security rules (H55) | Human capital investment (J24) |
| Changes in social security rules (H55) | Labor supply decisions (J22) |
| Decrease in social security benefits by 20% (H55) | Increase in labor supply later in the lifecycle (J20) |
| Increase in labor supply later in the lifecycle (J20) | Higher levels of human capital accumulation (J24) |
| Higher levels of human capital accumulation (J24) | Higher measured wage levels (J31) |
| Human capital depreciation (J24) | Declining labor supply (J20) |