The Effect of Old Age Pension Subsidy on Retirement Decisions: Evidence from Germany

by Han Ye, Boston University

The problem of poverty in old age requires increasing attention, especially in times of declining pension levels due to the aging population.  Using administrative pension insurance records from Germany, this paper studies the impact of a built-in minimum pension subsidy, implemented in 1992, on the labor supply decisions of low-pay old workers.  In particular, I investigate behavioral responses to the notch created by a discontinuous drop in pension benefits induced by this subsidy.  Essentially, average pension contribution at retirement being above 75 percent of the average insured will render one ineligible for this subsidy.  Empirically, I employ the change of density around the eligibility cutoff to estimate the labor supply elasticity of low-income older workers.  To construct the counterfactual density, I use the fact that the subsidy size depends on contribution years before 1992 and employ the distribution of younger comparable cohorts.  Additionally, the exogenous difference in subsidy size provides natural comparisons of behavior responses to different incentive intensities.  To further understand the behavior mechanisms behind the manipulation, I compare the labor supply trajectory of the intensities just to the right and to the left of the cutoff and set up a simple labor supply choice model with a lifetime budget constraint to explain the rationales behind it.

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