In response to the challenges of population aging, many countries have introduced gradual increases of the statutory eligibility age and shut down pathways to early retirement. There are, however, many incentives left which create early retirement, in particular less than actuarial adjustment factors and earnings tests, both of which are still frequent in Europe. Making adjustment factors actuarial and abolishing earnings tests are therefore often proposed as policies to strengthen the sustainability of public pension systems.
This paper employs a life-cycle model of consumption and labor supply with an endogenous choice of retirement (better: labor force exit) and, separately from this, choice of benefit claiming age to study the interaction between earnings tests and actuarial adjustments during the window of retirement. Earnings tests force workers to exit the labor market when claiming a pension. After abolishing the earnings test, workers can claim their benefits and can keep on working, potentially increasing labor supply. We show that the difference between exit and claiming age strongly depends on the preference for consumption versus leisure and can become very large. Moreover, we show that abolishing an earnings test as part of a so-called “flexibility reform” is likely to reduce the average claiming age when adjustments remain less than actuarial, hence worsening rather than improving the sustainability of public pension systems.
This project has resulted in a MEA Discussion Paper and was published under the same title in Economics Letters.