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One of the largest social insurance programs throughout the developed world is Disability Insurance (DI). In the U.S., the DI program has over 5 million beneficiaries and benefit payments of almost $40 billion (U.S. Department of Health and Human Services, 1994). In Canada, DI has approximately 340,000 beneficiaries, with benefits payments over $3 billion (Department of Human Resources). As a share of GNP, the two countries spend roughly the same amount on their DI programs.

In theory, DI provides benefits for workers who are physically incapable of finding suitable work. Disability would seem to be an ideal targeting device, allowing program administrators to divert resources towards those truly in need of income support. In practice, however, it is difficult to determine whether workers are truly disabled. A number of studies have revealed substantial error in the disability determination process.¹ The difficulty of appropriately identifying disability and the generous levels of benefits available have led many observers to claim that DI is largely distorting work decisions, and in essence subsidizing the early retirement of the older workers for whom appropriately defining career-ending disability is most difficult.

At the same time, other analysts have claimed that the vast majority of the DI recipient population is truly disabled and unable to pursue gainful employment, suggesting that any distortion to labour supply decisions is minimal. This argument implies that the welfare gains from redistributing resources to the low income disabled would outweigh any costs through reductions in labour supply. A critical input for evaluating this claim, and for modeling the appropriate level of DI benefits, is therefore an empirical estimate of the elasticity of response of labour supply to benefit levels.

There is a substantial U.S. based literature on the effects of DI benefits on labour supply. Evaluating this behavioral response in the context of the U.S. case has proved to be difficult, however. This is because the DI program in the U.S. provides benefits which differ across workers primarily through their past earnings histories. But one's earnings history will most likely be highly correlated with one's tastes for work at older ages, and it is difficult to disentangle the behavioral effects of DI from these taste differences. What is required to distinguish the effects of DI is differences in benefit levels across workers which arise independently of their underlying tastes for work at older ages.

Such differences have arisen in the context of the Canadian DI system. DI in Canada operates in much the same way as it does in the U.S., with the key difference being that the program is administered under two different plans: the Quebec Pension Plan, or QPP, which covers the province of Quebec, and the Canada Pension Plan, or CPP, which covers the rest of Canada. These two systems are identical in most respects. Since the early 1970s, however, disability benefits have risen more rapidly under the QPP. By the end of 1986, disability benefits under the QPP were substantially more generous than were benefits under the CPP, particularly for those disabled workers who had low earnings before their disability. Then, in January 1987, the CPP raised its benefit levels to equalize the generosity of the two systems. This resulted in a rise in benefits under the CPP of almost $2000 per year. On average, this represents a rise of 36 percent in the replacement rate of the CPP relative to QPP. This dramatic shift in differential benefits generosity is precisely the type of change that can be used to evaluate the labour supply response to DI benefits. That is, this policy change provides an opportunity to study the effect of changing DI benefits differentially for some workers (those not in Quebec) and not for others (those in Quebec).

The primary purpose of this evaluation study is to use this policy change to estimate the elasticity of the labour supply response for older persons with respect to DI benefits. The analysis uses data from the Survey of Consumer Finances (SCF), an annual cross sectional survey which collects information on demographic and economic characteristics. Data from the SCF is matched up with information on the benefits available under the CPP and QPP over time. Two types of estimates of the policy change are computed. The first is a standard "difference-in-difference" estimate which focuses on the labour supply effect of the large change in benefits in the rest of Canada relative to Quebec. The second is a more parameterized estimate that exploits the underlying variation in the impact of this policy change across workers within the CPP and QPP plans.

For both estimators, the results indicate that there is a large effect of benefits on the labour supply of older workers. The central estimates imply that the elasticity of labour force non-participation with respect to benefit levels is 0.25 to 0.32. This finding is robust to a variety of specification checks. Despite this large labour supply response, however, a simplified social welfare analysis suggests that the gains from this transfer to the relatively poorly off disabled under the CPP plan outweighed the net tax cost from financing this increase in CPP rolls, under plausible assumptions about preference parameters.

The report proceeds as follows. Part I reviews the key facts on the DI program in Canada, compares the Canadian system to that in the U.S., and reviews the empirical literature on the behavioral effects of DI. Part II describes the data, and Part III discusses the empirical strategy. Part IV presents the results for labour supply estimation, Part V considers the welfare implications of these findings and Part VI presents the conclusions.

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Footnotes

1	These studies are reviewed in parsons (1991a).