Estimation of a Structural Labour Supply Model for Belgium: Application to the Earnings Test for Pension Recipients

Abstract

In several OECD countries pension benefits are taxed away if retirees continue working and receive earnings that cross a threshold. Recently governments started to increase these earnings thresholds for working pensioners. On the basis of Belgian administrative data covering the years before and after such a reform, we show that bunching at a convex kink of the budget constraint tracks these tax rule changes. To account also for income effects along other parts of the piecewise-linear budget constraint, we estimate a structural labour supply model. A removal of the earnings test would lead to an increase of 2.44 hours worked per week but causes a budgetary deficit as well: pension benefits will be claimed earlier (as the deferral rate for pensions equals zero in Belgium) while social contribution revenues fall back. The intuition is that the income effect which leads high-earners to work less partly offsets the substitution effect which stimulates low-earner (previously at the convex kink) to work more.