Wage Subsidies and Fair Wages * Tomer Blumkin, Haim Pinhas and Ro’i Zultan 4 September 2018 Abstract Wage subsidies can be provided directly to the worker, or indirectly by subsidizing the employer; with reduced cost of labor, employers offer higher wages. The standard literature stipulates that this statutory inci- dence bears no implications for the economic incidence. We propose and test a mechanism by which indirect subsidies lead to higher social welfare. Studies show that workers reciprocate higher wages with higher effort. In- direct subsidies are shifted to the workers as higher wages, leading workers to reciprocate with higher effort and productivity. A controlled laboratory experiment supports our behavioral hypotheses and confirms the behav- ioral and welfare implications. Keywords: wage subsidies, welfare, gift exchange, tax incidence, laboratory ex- periment. JEL classification: C92, H21, H22, H53, J33 * We thank Gary Charness, Raj Chetty, Dirk Krueger, David Laibson, Omer Moav, Andreas Pe- ichl, Arno Riedl, Yona Rubinstein, Rupert Sausgruber, Jean-Robert Tyran, seminar participants at Bar-Ilan University, the Interdisciplinary Center Herzliya, Technical University of Munich, University of Vienna, Bank of Israel, and conference participants at the Economic Science As- sociation International Meeting, Jerusalem, CESifo Behavioral Economics Area conference, the Incentives and Behavior change conference, Tel-Aviv, CESifo Employment and Social Protection Area conference, and the European Economic Association meeting in Cologne for useful com- ments and discussion. This research was supported by the ISRAEL SCIENCE FOUNDATION (grant No. 552/14). 1