5) Social Security and Work: The Near and Distant Past (25 points)

From the 1930's until the early 1990's if an individual was receiving Social Security (retirement income, any dollar they made from work led to a dollar reduction in their benefit. This effectively provided a wage rate of 0$/hour for seniors. In practice it meant that those receiving Social Security would either work for cash in secret or just not work.

In the early 1990s, the policy regarding working retirees was adjusted in the following way. (new policy 1) Retirees could now work and keep their full benefit of $900 a month (the average benefit size at the time). However, earnings up to $1,000 a month were taxed at the rate of 30%. Beyond $1000 a month, earnings were taxed at a rate of 100%.

The next policy change came in the mid 1990's. (new policy 2) The new policy allowed retirees to keep the full amount of their monthly benefit (assume $900 again). In addition, they would be able to earn up to $200 of earned income untaxed, with an additional $1,000 of earnings taxed at a rate of 20%. Any income beyond that would be taxed at 100%.

a). Show and explain these two policy changes (first policy 1 on a graph, then policy 2 on a separate graph) would change the work incentives of a representative senior with a $900 Social Security benefit. Explain and graph the changes displaying relevant budget constraints and indifference curves. Be sure to discuss and contrast each policy's implications for labor supply. (15 points)

b). The current policy was set in the year 2,000. Those retired, but aged 62-66 could keep their entire Social Security Benefit and earn up to $1,310 per month with no tax on their income. Any income above this amount will be taxed at a rate of 50%. Those at full retirement age (66 and older) are allowed to earn as much income as possible with a 0% tax. On the same graph, show the effects on work effort for a 63 year old as compared to a 67 year old with identical preferences and wages. (10 points)