Bryan Caplan  

Means-Testing and Behavioral Econ

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I'm a big fan of means-testing (see here, here, and here for starters).  Analytically, though, stringent means-testing is indistinguishable from high marginal tax rates.  In both cases, the government takes away a big chunk of every dollar you earn.  Philosophers may say, "There's a moral difference between taking away what you've earned and giving you less of what you haven't earned."  Selfishly speaking, though, they are the same.

For dogmatic neoclassical economists, this settles the question.  But no one should be a dogmatic neoclassical economist.  Empirically, the equivalence remains an open question.  Behavioral economics has repeatedly shown us that framing matters; people may simply fail to mentally equate "marginal benefit reduction" with "marginal tax increase."  This is especially plausible when the marginal benefit reduction happens far in the future, and the benefit formula is poorly defined in any case.

Take me.  Conceptually, I know that my future Social Security benefits have something to do with how much I pay in Social Security taxes.  Yet when I weigh whether to pursue extra income, I've honestly never considered this effect.  In my mind, I round that eventual gain down to zero. 

Of course, if means-testing gets adopted before my retirement, my rounding down to zero will turn out to be justified.  But as far as I can tell, most people round down to zero - even if they plan to retire long before means-testing is likely to be adopted. 

On what basis do I say "As far as I can tell"?  Simple: I've never heard anyone - even a fellow economist - claim to factor extra Social Security benefits into a personal cost-benefit calculation.  Indeed, the only time the issue even comes up is in discussions of public policy.  Many people, in contrast, openly discuss how taxes affect their behavior.

While I believe in the power of introspection, I'd definitely like to supplement my introspection with careful empirical research on this topic.  Yet Google Scholar seems oddly empty of articles on the topic.  Question: Is there any scholarly evidence - pro or con - that I'm missing?  If so, please share.

COMMENTS (20 to date)
Andrew C writes:

Could it be that you don't notice this because you are fairly well off and there are few means tested programs you can take advantage of, and those are paying off benefits in the indefinite future rather than the here and now?

For members of the working poor contemplating losing some benefit but taking a higher paying job I would expect that loss aversion would mean that they would be more adverse to the new job than pure calculation would suggest. On the other hand, I know that I personally have only the vaguest idea when the cutoffs for various programs are, and I could also believe that most people who lose social benefits are ignorant that they're about to do so.

Floccina writes:

When I was a child I heard a discussion of someone wanting their wife to go back to work for a few years so that she would qualify to collect SS or more form SS. I have also heard people warn other people who are working for cash that they need to get a taxed job so that they will be able to get SS.

So IMO SS should pay all retirees about $700/month rather than be means tested.

Jared writes:

My father recently took early retirement (instead of being included in a round of firings). As he's only 62, he is making the conscious decision of living off of only his retirement savings/investments until the age of 70, when SS benefits will maximize for him. He says that he treats SS as insurance against living too long.

Silas Barta writes:

Isn't this just the "average vs marginal" issue (or mistake)? Yes, it may be very hard to find such a person, but as long as there are such "marginal people" at all, they will determine the equilibrium price and quantity.

Daublin writes:

I'm guessing most people frame social security as just a safety net. It's not a real retirement plan, but rather, a retirement of last resort. People probably think differently about their 401ks.

Among other issues with social security, it's hard to predict what the U.S. government will do a decade or more in the future. Moreover, the best way to game it is constantly changing, and who has time to keep track of it?

Pat writes:

Where is your evidence that people fail to take into account implicitly high marginal tax rates from phased out benefits?

I'm not aware of any behavioral lab experiments that have the same high stakes as the lost benefits calculation outside the lab.

People become much less irrational with lots of money at stake.

Carl writes:

I'm 31, so I just assume my Social Security benefits will be zero, period.

David C writes:

To me personally, they're equivalent because I keep both at zero. When determining how much money, I spend, I look at my take home pay and compare it to expenses. When determining my job prospects, I don't bother calculating tax rates on different incomes. If one job pays $1,000 dollars more a year or i receive a small raise, I just think of that as a little bit more, it's hard enough factoring in differing retirement and health benefit rates without having to include slight income tax differences and government benefit eligibilities.

Tracy W writes:

As a Kiwi I've heard plenty of people discuss the phasing out of benefits in terms of less cash income as family income goes up.
There's not an equivalent of the SS structure though in nz and in Britain people don't seem to discuss the NI incentives.

David R. Henderson writes:

Take me. Conceptually, I know that my future Social Security benefits have something to do with how much I pay in Social Security taxes. Yet when I weigh whether to pursue extra income, I've honestly never considered this effect. In my mind, I round that eventual gain down to zero.
But even if you did consider it, it would be almost exactly zero. The reason: the income taxed for SS is the first $117,000. My guess is that with your George Mason University pay and your free-lance income you already make, you’re above that number. So your incremental tax and benefit are both zero.

MingoV writes:

Social Security already uses means testing. I'll show this using a simple example that assumes no inflation, no salary changes, and retirement in 2020 at age 70.

Lonny makes $40,000.
Hillary makes $80,000.

Hillary's Social Security payroll deductions are twice as much as Lonny's. However, on retirement, Hillary's benefits are only 1.6 times Lonny's, or 20% less than expected.

If you compare a worker whose full-time wages always were at the minimum wage to a worker whose full-time wages always were above the Social Security payroll deduction cut-off, the benefits of the latter are more than 50% lower than would be expected by the salary ratios.

If the government implements means testing for receiving benefits, than the higher wage earners will get screwed twice.

Handle writes:

It's kind of like the apocryphal Pauline Kael 'quote', "I can't believe Nixon won, I don't know anyone who voted for him."

I can definitely vouch for Floccina's story, and I've heard versions of Jared's father's story as well.

As a factoid: USSSA says, "If you retire at age 70 in 2013, your maximum benefit would be $3,350."

FMB writes:

In this case, the lack of attention increases DWL. More transparent benefits would increase appreciation and lower perceived tax rates.

ThomasH writes:

Exactly the same reasoning that leads me to doubt that high-earning individuals decide to earn less because of marginal tax rates anywhere near what they are in the US today.

Thomas Boyle writes:

I'm very much aware of the social security benefit.

Also, ThomasH, yes, high-earning individuals DO decide to earn less because of current (50%+) marginal tax rates. Women leave the workforce (well-documented), and I personally know men who have chosen lower-stress lifestyles after figuring out that the after-tax hit wouldn't really be so bad, compared to spending their lives in the office to pay taxes.

Brent writes:

It certainly makes a great difference in real time, though. I used to work with a retired lady who would calculate to the minute how much she worked each week so as to not lose Social Security benefits.

David C writes:

"high-earning individuals DO decide to earn less because of current (50%+) marginal tax rates. Women leave the workforce (well-documented)" - Thomas Boyle

I'm curious, where is this well-documented? That would seem like a rather difficult thing to demonstrate conclusively.

David C writes:

Just to clarify, yes, you could demonstrate that high-income women leave the workforce more than mid-income women, and fine if you want to link to that research but that doesn't demonstrate that it's due to marginal tax rates. I want that evidence. I could just as easily make the opposite argument that taxes aren't high enough because we need to increase women's labor force participation rate by lowering their incomes using the same piece of evidence.

CC writes:

I'm starting to think the behavioral econ is just an excuse for people to ignore basic economic principles in their arguments whenever it's convenient to do so.

pyroseed13 writes:

Bryan is exactly right. Many of my fellow libertarians and conservatives continue to assert that the poor respond to implicit marginal tax rates, yet there is simply no evidence of this. The definitive paper on this topic was written by economist Robert Moffitt over at Johns Hopkins, who found that our welfare programs only have a small impact on employment. Unfortunately, failing to acknowledge this has led some of those on the right to propose "negative impact taxes" and "guaranteed minimum incomes," which studies have shown to impact negative impacts on employment.

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