Using Non-Linear Budget Sets to Estimate Extensive Margin Responses: Method and Evidence from the Social Security Earnings Test

We develop a method for estimating the effect of a kinked or notched budget set on workers’ employment decisions, and we use it to estimate the impact of the Social Security Old-Age and Survivors Insurance (OASI) Annual Earnings Test (AET). The AET reduces OASI claimants’ current OASI benefits in proportion to their earnings in excess of an exempt amount. Using a Regression Kink Design and Social Security Administration data, we document that the discontinuous change in the benefit reduction rate at the exempt amount causes a corresponding change in the slope of the employment rate. We develop conditions in a general setting under which we can use such patterns to estimate the elasticity of the employment rate with respect to the effective average net-of-tax rate. Our resulting point estimate for the AET indicates an elasticity of at least 0.49, suggesting that the AET reduces employment by more than one percentage point in the group we study.