Incidence, salience, and spillovers: The direct and indirect effects of tax credits on wages

Tax credits are a popular way to alleviate in-work poverty. A common empirical assumption that the benefit of the tax credit is borne solely by the claimant workers. However, theory suggests no particular reason why this should be the case. This paper the impact of the Working Families’ Tax Credit, introduced in the UK in 1999, wages. Unlike similar tax credit policies, this tax credit was paid through employers rather directly to workers, making it more salient to the employer. Using a novel identification, we can separately identify the effect on wages associated with an increase in the of tax credit and that associated with the change in salience. We find evidence that:(1) through the salience mechanism the firm cuts the wage of claimant workers relative to skilled non-claimants by 30 percent of the tax credit, which is approximately 7 of the wage, and (2) there is a negative spillover effect onto the wages of claimant non-claimant workers of 1.7 percent, which is approximately 8 percent of the tax credit claimant workers.