Optimal Retirement and Disability Benefits with Audit

This paper studies the design of retirement and disability policies when individuals differ in both productivity and health. The second-best solution implies (downward) distortions in the (per-period) labor supply and in the choice of retirement age for some individuals, and lesser redistribution towards workers with poor health and low productivity. This problem can be mitigated when disability screening is available. Optimal disability screening involves a random component; it is never optimal to audit all individuals who claim to be disabled. The optimal audit probability strikes a balance between audit costs and benefits obtained by relaxing an otherwise binding incentive constraint.