Take-Up and Labor Supply Responses to Disability Insurance Earnings Limits

Abstract

In most disability insurance programs, beneficiaries lose some or all of their benefits if they earn above an earnings threshold.  While intended to screen out applicants with high remaining working capacity, earnings limits can also distort the labor supply of beneficiaries.  We develop a simple framework to evaluate this trade-off.

We use a reduction in the earnings limit in Hungary to examine screening and labor supply responses and analyze administrative panel data that brings together information on earnings, occupations, benefit receipt, healthcare spending, and other domains for half of the Hungarian population over the 2003-2017 period.

To study how the reform impacted the selection of beneficiaries into the Regular Social Assistance (RSA) program and their labor supply conditional on participation, we compare beneficiaries who entered in 2007, the year before the reform (“old entrants”), and beneficiaries who entered in 2008, the year after the reform (“new entrants”).  We follow these two groups of beneficiaries for four years before and three years after they enter disability insurance.  We start our empirical analysis by comparing selection into the RSA program between old and new entrants.  In particular, we compare program inflow, observed characteristics of entrants and their labor market outcomes in the years before entry.  This analysis should give us a good sense of the overall selection effect due to the reform.  Next, we compare labor market outcomes of old and new entrants after disability entry.  To interpret these differences as labor supply effects from the change in the earnings limit, we have to control for the selection effects, which we do in regression and reweighting analyses.

We find that the policy changed selection into the program modestly but reduced labor supply significantly.  Viewed through the lens of our model, these findings suggest that the earnings threshold could be higher.

A limitation of our analysis lies in its comparability with other disability programs, given that the Hungarian RSA program offers a very low, flat-rate benefit specifically designed for moderately disabled individuals.  However, our results lead to a general conclusion that the low earnings limit discourages beneficiaries from fully utilizing their remaining working capacity.

The paper found that:

• The decrease in the earnings limit had a small impact on selection into the program.  First, we do not find evidence of decreased program entry rates.  Second, consistent with the screening mechanism, we show that individuals who entered the program after the reform (new entrants) had worse pre-entry labor market outcomes than beneficiaries who had entered earlier (old entrants).  Though new entrants were slightly less likely to work and earned somewhat less on average pre-entry than old entrants,  old and new entrants were similar on a variety of dimensions, such as age, occupation, geographical location, and sick leave use prior to entering disability.
• Individuals who entered the program after the earnings limit was reduced had meaningfully lower labor supply post-entry.  New entrants were as likely to be employed as old entrants, but conditional on being employed, they worked less.  On average, new entrants worked 7 percent fewer hours, and had 18 percent lower earnings (conditional on working) after taking up benefits.
• This result is driven by the beneficiaries with higher pre-disability earnings, who were most affected by the change in the earnings limit.

The policy implications of the findings are:

• We show conceptually that with the choice of the earnings limit, policymakers must trade off selection and labor supply effects.
• Our results suggest that decreasing the earnings limit only led to a moderate improvement in screening efficiency.  This evidence is consistent with a scenario where the earnings limit and benefit level before the reform were already sufficiently low to deter potential entrants who are well-positioned to find higher-paying jobs in the labor market.
• At the same time, the reform substantially distorted the labor supply of program participants, indicating that individuals with moderate disabilities react sensitively to the financial incentives embedded in disability benefits.
• Too-strict earnings limits fail to yield sizable cost savings from benefit expenditures for the government but leave moderately disabled individuals with lower earnings, resulting in lower tax revenues.