Taxing Work

Why do people leave the labor force and retire? As they get older, some people have to retire. But for most people in the developed world, retirement is a choice. The choice to retire involves a trade-off between the benefits and costs of work and the benefits and costs of leisure. And governments influence this trade-off through tax and retirement policy. In the United States and most other developed countries, for example, workers can collect payments from a government-run retirement system once they reach a certain age.

In the U.S., workers can collect as early as age 62. In other countries, the earliest retirement age is usually about the same, although it can be a little bit higher or a little bit lower. Naturally, most workers won't want to retire until they can start collecting benefits. So, the earliest age at which workers can collect benefits influences the choice to retire. Not everyone who is old enough to collect benefits, however, will want to retire. Some people -- they just love their jobs. Government policy, however, also influences the choice of workers who don't want to retire. For example, older workers in the United States are much more likely to stay in the labor force than older workers in Italy, France, or the Netherlands.

How come? In the United States, workers who want to continue working past the early retirement age -- they're not heavily penalized. But in the Netherlands, for example, workers who continue to work after the age of 60 -- they lose a significant portion of their retirement benefits. Imagine you're about to turn 60 in the Netherlands. If you keep working, you lose some of your retirement benefits, plus you're still having to work and pay taxes on your earnings. Taking all of this into account, it could actually be the case that you’d make more if you retired than if you worked. Put another way, in the Netherlands, some elderly people have to pay to work. Not surprisingly, most of them choose to retire.

In this graph, we're going to plot the labor force participation rates of older males, ages 55 to 64, on the vertical axis. We look at males simply to reduce the number of variables and increase clarity. On the horizontal axis, we're going to graph the implicit tax rate. The implicit tax rate captures in a single index both the actual taxes paid on earnings as well as penalties, such as losing retirement benefits. Countries like Belgium, France, and the Netherlands, with some of the highest implicit taxes on working, are also those with the lowest participation rates.

In other words, the higher the implicit tax on working, the fewer older men choose to work. Taxing older workers and encouraging them to drop out of the labor force and collect retirement benefits? This has proven to be an expensive policy in Europe, especially as the population has aged. As a result, many European governments, including the government in the Netherlands -- they've been working to reform their retirement systems and to reduce implicit tax rates.

Okay. Government policy, of course, isn't the only force that can change the incentive to work. In the next video, we're going to take another look at the female labor force participation rate. This time we're going to focus on a technology, a technology that changed incentives and also profoundly changed our culture. It's an amazing story -- one of my favorite insights from economics. This technology also inspired a hit song by Loretta Lynn. That's the topic we turn to next.