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Income Effects and Labour Supply: Evidence from a Child Benefits Reform

In this paper, we exploit a unique and unexpected reform to the child benefit system in Denmark to assess the effects of child benefits on parental labour supply. A cap on child benefit payments in 2011 led to a non-negligible reduction in child benefits for larger families with young children. The differential impact of this policy shift represents an opportunity to assess the causal impact of child benefit programmes on the labour supply of mothers and fathers. As a new government was elected in late 2011, the reform was repealed after being in place for a single year, which allows us to assess long term effects of a temporary income shock that was perceived to be permanent. We find that a reduction in child benefits leads to a large increase in the labour supply of mothers; the effect on fathers is much smaller. Both mothers and fathers respond to the policy at the intensive margin, but the strongest response is from mothers at the extensive margin. The majority of the effects can be ascribed to fertility responses, but even after controlling for fertility-related family characteristics, we find significant increases in labour supply after the introduction of the reform. We confirm this result by using data on parents’ consultations with doctors regarding sterilisation, a common procedure in Denmark. Lastly, the labour supply effects of the reform are generally sustained for at least 3 years after its repeal. ∗This paper has benefited substantially from discussions with Fane Groes, Herdis Steingrimsdottir, and Caroline Hoxby. †Copenhagen Business School, Department of Economics, corresponding author (email: mfj.eco@cbs.dk) ‡London School of Economics, Department of Economics 1