EALE/SOLE 3rd International Conference, held 17-19 June 2010, University College London, UK
June 1, 2010
This paper formulates a simple model of female labor force decisions which embeds an in-work benefit reform and explicitly allows for announcement and anticipation effects. We stress two mechanisms through which women can respond to the announcement of a reform that increases in-work benefits, namely, intertemporal substitution and labor market frictions. Simulations show that those two mechanisms lead to opposite changes in female labor force participation before the implementation of the reform. If labor market frictions dominate, we expect a positive pre-reform effect on labor supply; while if intertemporal substitutability dominates, then we expect to observe a reduction in labor market participation between the announcement and the implementation of the reform. We use this result to analyze the effects of a major UK in-work benefit reform, the Working Families' Tax Credit (WFTC), on single mothers' behavior. We find that there are large and positive announcement effects on eligible employment decisions (that is, working 16 or more hours per week), which suggests that women's responses are consistent with a story based on labor market frictions rather than intertemporal substitution. Treatment effect evaluations based on pre-post reform outcome comparisons that ignore such announcement effects produce estimates that are biased downwards by 15 to 35 percent. These results emerge also in the case of other labor supply margins, such as full time employment, labor market participation, hours worked, and labor market transitions.