Benefit Salience and Labour Supply

I study the salience of dynamic incentives provided by the welfare system, as revealed by labour supply responses to foreseeable reductions in benefit income. I show that claimants fail to anticipate a large lump-sum reduction in benefit entitlement, arising predictably from children ageing out of eligibility for the UK’s Child Tax Credit. I show also that the salience of the rules increases with experience. I then develop a structural life-cycle labour supply model incorporating potential non-salience of eligibility rules. The model estimates suggest that 82 percent of claimants initially fail to anticipate the benefit reduction. The resulting optimisation errors have substantial welfare costs—equivalent to a 14 percent reduction in income from the programme, with no offsetting benefits to the government. The findings reveal a previously undocumented source of inefficiency in the welfare system, arising from non-salient policy features with significant financial consequences.