Personal Income Tax Salience: Evidence from the Child and Dependent Care Credit Expansion

This paper examines how consumers respond to a change in a personal income tax provision when there are interactions with other elements of the tax code which makes the financial implications less salient to the taxpayer. We use data from the Consumer Expenditure Survey to provide evidence that taxpayers responded to the 2003 expansion of the Child and Dependent Care Credit without considering important interactions. Taxpayers who only considered the 2003 change to this tax credit would have perceived that the after-tax price of child care had decreased. However, we show that for many low-income taxpayers, the after-tax price of child care actually increased due to interactions with other elements of the tax code, particularly the increase in the value of the Child Tax Credit. Using a difference-in-differences estimation strategy which exploits the heterogeneity in the size of the perceived and actual change in the value of the Child and Dependent Care Credit, we find strong evidence of a child-care expenditure response to the perceived change and no evidence of a response to the actual change. Through falsification exercises we rule out several alternative explanations and interpret the effect as causal. This evidence implies that the low salience of the personal income tax can be used to induce a taxpayer response without providing any actual financial incentives.