This study analyzes the extent to which individuals adjust their behavior in response to such welfare reform announcements, and if so, whether these responses are economically meaningful and whether they can be understood within standard economic principles. We illustrate this issue using a simple female labor supply model which allows for labor market frictions and intertemporal substitution between leisure and work. After provide explicit solutions to the model, we perform a simulation exercise which considers a number of policy scenarios (e.g., excluding or allowing for announcement of the reform, and excluding or allowing for responses to such announcements even before the actual introduction). We then apply this analysis to one specific example, the announcement and the introduction of the 1999 British tax credit reform. We consider single mothers and estimate their labor market and childcare utilization responses. We find strong evidence in support of announcement effects which is consistent with a labor market friction story but not with a story driven by intertemporal substitution. Ignoring such responses leads to treatment effect estimates that are downward biased, with a bias ranging between 15 and 35 percent in the case of the outcomes along the employment margin. |
