The goal of this proposal is to provide a framework for understanding how disability risk and the features of the Social Security Disability Insurance (DI) program in the US affect consumption and labor supply behavior in an explicit life-cycle setting. Analyses of the DI program are a growing topic of research, but they are still relatively underfunded and understudied. For example, Unemployment Insurance (UI) is a much more studied program than DI, especially by macro and labor economists. This is despite the fact that in 2007 DI paid cash benefits totaling $99.1 billions, three times more than UI. The DI program is also growing very fast. For example, between 1985 and 2007 the proportion of people on DI doubled, from 2.4 of the covered population to 4.7 percent. Most researchers now agree that the DI program is growing at unsustainable rates. The financial sustainability of the whole U.S. social insurance system may be affected. The recent growth in the size of the DI program has renewed the calls for a redesign of the program aimed at reducing benefits generosity, increasing strictness in the definition of a qualifying disability, and in general reducing the extent of what is known as the moral hazard problem of DI, i.e., non-disabled individuals applying for benefits and being admitted into the program. The existing empirical literature has indeed found convincing evidence for the existence of moral hazard effects, mostly based on reduced form analyses. For example, there is a large literature documenting a positive effect of DI benefits on DI application and a strong correlation between fall in participation and rise in generosity of disability insurance. On the other hand, due to the unobservability of the true disability status, any restriction in the access to the program would necessarily deny insurance to some deserving individuals. Some of the existing structural studies have tried to measure the welfare value of having the DI program in place. A lot has been learned from these earlier papers.
This proposal would develop a life-cycle theoretical framework that is rich, realistic, and relaxes most of the simplifying assumptions made in the earlier literature. It would estimate the parameters of the model and then use this theoretical framework to evaluate alternative policies weighting the inefficiency of the program against the insurance it provides. In particular, it would evaluate the importance of the disincentives to work and save generated by the program. It would also plans use this framework to analyze behavior in alternative economic environments, specifically, how individual behavior responds to changes to the features of the DI program (such as making the program less generous) or to the introduction of new ones (such as policies aimed at moving some DI beneficiaries back to work).
The proposed model tries to strike a balance between realism and feasibility. It allows for life cycle saving and complex wage dynamics, on the ground that, given the opportunity cost of applying for DI benefits and the fact that health also affects individual productivity, moral hazard considerations should be more relevant when wage shocks are permanent than if they are temporary. The proposed preference specification allows for non-separability between consumption, leisure and health status (this means that a fall of consumption on disability does not necessarily indicate a welfare loss, but a way to smooth consumption across states). Finally, the model allows for interactions between the DI program and other social insurance programs, as well as labor market frictions. Structural parameters of the model will be identified using Indirect Inference and longitudinal data from SIPP and PSID. The model is used to evaluate the welfare effect of various program changes: (a) Increasing the strictness of the disability test; (b) Changing the probability of re-assessment for DI; (c) Changing the progressivity of DI payments, and (d) Reducing the costs of work or increasing job opportunities for people with disabilities, etc.
Broader impact: The ability to evaluate the welfare effect of the changes above in a coherent unified framework has important policy implications. Some of these changes have been explicitly considered as possible solutions to the moral hazard problem underlying the expansion of DI rolls of the last two decades. This expansion represents a direct cost for the program because fewer individuals contribute to its financing. Given that the DI program is part of the Social Security system, its forecast expansion has important implications for long-term sustainability of the Social Security system as a whole.
