Equilibrium Search and Tax Credit Reform

An empirical equilibrium job search model with wage posting is developed to analyze the labor market impact of UK tax reforms. The model allows for a rich characterization of the labor market, with hours responses, accurate representations of the tax and transfer system, and both worker and firm heterogeneity. The model is estimated with pre-reform longitudinal survey data using a semi-parametric estimation technique, and the impact of actual tax reform policies is simulated. The model predicts that the British Working Families’ Tax Credit and contemporaneous reforms increased employment, with equilibrium effects found to play a relatively minor role.