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

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

Abstract: We incorporate time-averaging into the canonical model of Heckman, Lochner, and Taber (1998) (HLT) to study retirement decisions, government policies, and their interaction with the aggregate labor supply elasticity. The HLT model forced all agents to retire at age 65, while our model allows them to choose career lengths. A benchmark social security system puts all of our workers at corner solutions of their career-length choice problems and lets our model reproduce HLT model outcomes. But alternative tax and social security arrangements dislodge some agents from those corners, bringing associated changes in equilibrium prices and human capital accumulation decisions. A reform that links social security benefits to age but not to employment status eliminates the implicit tax on working beyond 65. High taxes 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