This paper uses the Health and Retirement Study to explore how local cost-of-living affects Social Security replacement rates and household behavior. In theory, labor markets with high cost-of-living also offer more compensation. If this compensating differential is paid in wages, rather than benefits, it reduces the share of earnings replaced by Social Security due to the progressive benefit structure. This paper examines how important the cost-of-living penalty is, in practice, and whether it impacts households’ saving or labor supply.
The paper found that:
- Households in high-cost areas do receive higher wages and lower Social Security replacement rates, but geographic variation in replacement rates is economically small.
- Unsurprisingly, given these findings, households’ response is muted, with small adjustments concentrated among affluent households.
The policy implications are:
- Social Security’s progressive benefit structure could penalize households whose local labor markets have high cost-of-living.
- Recent cohorts of beneficiaries have only faced a small penalty because wages have not kept pace with prices in high-cost areas.