A tax plan that rewards putting off retirement

September 27, 2012: 10:16 AM ET

Washington, take note: Giving workers aged 55 and up a payroll tax break could add hundreds of billions to the nation's coffers, while slowing a Boomer brain drain.

FORTUNE -- With tax policy front and center in election-year debates, two economists at the University of Michigan's Retirement Research Center have come up with a proposal that pols might want to ponder: Give every working American an automatic 10% pay raise at age 55.

Huh? "Our idea is to lower payroll taxes on an individual precisely at the time of life when people are making decisions about whether to work longer or retire," says Dan Silverman, co-author of a study called Consumption, Retirement, and Social Security: Evaluating the Efficiency of Reform that Encourages Longer Careers, published in The Journal of Public Economics.

If everyone stopped paying Social Security taxes beginning at age 55, the research shows, the resulting 10.6% boost in take-home pay would encourage people to retire an average of 1.5 years later than they otherwise would. That means they'd pay more income taxes, helping to shrink the federal deficit.

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"People are living longer, healthier lives, and so far have opted to take most of that extra time as additional retirement rather than work," says co-author John Laitner. "We believe targeted tax-rate changes would reward older workers for staying on the job and also benefit the economy as a whole."

Employees would need to pay roughly 1% higher payroll taxes a year until age 55 for the Social Security system to break even, according to the study. This would mean that, over their lifetimes, the average household would pay about $15,000 more in federal income tax. As is the case in the current system, retirees could claim Social Security benefits as early as age 62, although waiting at least three more years would continue to be rewarded with higher benefit levels.

"Not everyone would benefit under our plan," Laitner acknowledges. "People with a strong preference for very early retirement would pay the slightly higher payroll tax before age 55, but leave the labor force before gaining anything from the elimination of the payroll tax after that. Late retirees, by the same token, would be big winners."

Their employers would win, too. Before the recession struck, you may recall, many big companies feared that a mass exodus of Boomer employees, all reaching retirement age at once, would take their hard-to-replicate experience and expertise out the door with them -- without first passing it on to younger colleagues.

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That dreaded brain drain was slowed to a trickle by the economic downturn, which a Towers Watson study says caused as many as one in three older workers (especially those without defined-benefit pensions) to delay their retirement. Since last year, however, the compensation consulting firm reports that retirements have been accelerating again. By rewarding longer careers with a smaller tax bite, the researchers' plan might encourage more people to stick around long enough to impart their knowledge to coworkers before heading for the exits.

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About This Author
Anne Fisher
Anne Fisher
Contributor, Fortune

Anne Fisher has been writing "Ask Annie," a column on careers, for Fortune since 1996, helping readers navigate booms, recessions, changing industries, and changing ideas about what's appropriate in the workplace (and beyond). Anne is the author of two books, Wall Street Women (Knopf, 1990) and If My Career's on the Fast Track, Where Do I Get a Road Map? (William Morrow, 2001).

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