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Models usually implicitly assume that people are aware of the incentives they face. People in a labor supply model, for example, usually make their decisions based on the actual schedule, not their subjective impression of the schedule. But many people may not even be aware of changes in income taxes schedules: how can they then respond to changes in the schedule? In current research, Raj Chetty, John Friedman, and Emmanuel Saez turn this apparent difficulty into an advantage. They estimate the causal effect of changes in an aspect of the income tax schedule on labor supply. Since the policy they study is Federal, there is not much variation to identify the effects of interest using traditional methods, but the authors show how to recover regional variation in knowledge of the schedule. The interaction of knowledge and the schedule then varies across regions and time even though the schedule only varies over time, so there’s lots more variation to identify the effect of the schedule on labor supply.

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