The effect of a Social Security system on the decision to retire is a matter of
considerable controversy. Among the aspects of such systems causing debate
have been the existence and effects of imperfect capital markets, the purported
incentives embodied in "earnings tests, "the degree of actuarial fairness in such
systems, and the degree to which incentives increase or decrease at certain
critical ages (62 and 65 in the United States). The present article contains an
analysis of the retirement decision that illuminates many of these issues and
provides new insights into the effects of Social Security on retirement. Using a
straightforward labor-leisure model and associated analytical diagrams, the
article shows the labor-supply effect of actuarial unfairness in the benefit
formula, the impact of an earnings test in causing workers to postpone retire
ment (thus increasing lifetime labor supply), and the impact of imperfect capital
markets on the timing of retirement.
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