Time Averaging Meets Labor Supplies of Heckman, Lochner, and Taber

Graves, Sebastian; Gregory, Victoria; Ljungqvist, Lars; Sargent, Thomas J.

doi:10.20955/wp.2023.012

Working Paper Revision

Time Averaging Meets Labor Supplies of Heckman, Lochner, and Taber

Abstract: We add endogenous career lengths to the Heckman, Lochner, and Taber (1998a) (HLT) model with its credit markets and within-period labor supply indivisibilities, all of which are essential features of Ljungqvist and Sargent (2006) “time-averaging.” A benchmark social security system puts all workers at corner solutions of their retirement decisions. That lets our model reproduce most outcomes in HLT’s model with its inelastic labor supply and mandatory retirement date for all types of workers. Eight types of workers are indexed by pairs of innate abilities and choices of education levels. Tax and social security arrangements can dislodge some types of agents from those corners, bringing associated changes in equilibrium prices, college enrollments, and on- the-job human capital accumulations. A reform that links social security benefits to age but not to employment status eliminates an implicit tax on working beyond age 65. High tax rates with revenues returned lump-sum keep agents off corner solutions, raising the aggregate labor supply elasticity and threatening to bring about a “dual labor market” in which many people decide not to supply labor.

Keywords: time averaging; labor supply elasticity; retirement; taxation; Laffer curve; social security reform;

JEL Classification: E24; E60; J22; J26;

https://doi.org/10.20955/wp.2023.012