Optimal Social Security with Imperfect Tagging

Workers are exposed to the risk of permanent disability. We rely on a dynamic mechanism design approach to determine how imperfect information on health should optimally be used to improve the trade-off between inducing the able to work and providing insurance against disability. The government should offer back-loaded incentives and exploit the information revealed by the gap between the age at which disability occurs and the age of eligibility to disability benefits. Furthermore, the able who are (mistakenly) tagged as disabled should be encouraged to work until some early retirement age.