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Childcare should be tax deductible

By Richard Holden  March 05, 2015


If you want a recipe for a really bad public policy debate, combine the following ingredients: taxes, government spending, children’s welfare, gender equity and jobs.

However, there is one simple answer to the debate on childcare in Australia. Taxation.

The Productivity Commission has now delivered its long awaited report on the matter. Its answer? It’s all terribly complicated. According to the commission, we need sliding scales and means tests, carve outs and exemptions. It’s all a balancing act that can only be performed by a bureaucrat’s Excel spreadsheet.

I’m not convinced. It’s much simpler than that. Just make it tax deductible.

The reality is that childcare subsidies are not very complicated. We don’t need big, thick reports to get to the right answer. And we can do away with most of the agonised commentary as well.

So let’s take a deep breath and get back to first principles about childcare subsidies.

Why does the government subsidise some things and not others? Two reasons. The first is dignity. We believe that everyone who lives in Australia should have a basic level of human dignity.

So we provide a basic level of services for health, education, housing and other things. And so we should. It’s part of what makes Australia a great country. In some cases, this will also include the provision of childcare. For disadvantaged parents, affordable childcare can be essential to the ability to earn a basic living.

Existing policies on childcare also reflect this understanding, though rising costs may be putting access of this kind under pressure.

The second reason government subsidises things is because free markets – though great – don’t always get everything right. In the language of economics, sometimes there are “externalities”. Government subsidies are a way of “internalising” those externalities – a way of preserving the magic of the market, but getting the price signals right.

And so it is—or at least should be—with childcare. The market, left to its own devices, would provide too little and parents would consume too little childcare.

Why? There is a swathe of evidence – such as that from Nobel prize-winning economist Jim Heckman – that quality early childhood care has particularly large benefits for disadvantaged children.

Formal childcare can be essential to addressing the needs of disadvantaged children in ways that mean they also require less support from society later in life. This is the whole idea behind “head start” or early intervention.

Affordable childcare is also important to supporting job-market participation by parents, and particularly women. This has important gender-equity implications, which society as a whole should care about.

But it also has critical economic implications in terms of job-market participation and overall workforce productivity. Remember that G20 pledge Tony Abbott (correctly) made?

With taxes on income and a free market for childcare, parents rationally under-consume childcare. The playing field is tilted in favour of them doing more of it themselves because they are not taxed on the labour they provide in taking care of kids, but have to pay in after-tax dollars for market-based childcare.

Tax deductibility of childcare levels the economic playing field. Case closed.

There may be good arguments – based on dignity and the needs of disadvantaged children – for providing childcare subsidies. Those subsidies should also keep pace with changes in the costs and structure of the industry in ways that may warrant some form of government Excel spreadsheet.  But the key challenge on childcare is about economic participation.

In this context, we subsidise childcare not because it’s like healthcare, or a basic right, but because income taxes distort people’s decisions about how much time to spend at work versus at home.

Those  income taxes are vital for a whole range of reasons, but when they distort other decisions – such how much to give to charity – we fix it by making things tax deductible. And that’s precisely what we should do with childcare.

There is, of course, a complicated set of questions about who should provide childcare, and standards and accreditation. Sometimes, we might have good reason to want to insist that children be cared for in a formal setting: there are strong arguments for the educational and social benefits of formal daycare.

These benefits may also be especially important for disadvantaged or socially isolated children. In other contexts, we might think that parental flexibility, or individualised care, is more important.

But just because the government pays for (part of) something doesn’t mean they need to set up a separate agency to oversee how it is provided. In most cases, we think that parents are well placed to decide how best to spend any subsidy, or tax-deduction, they receive for childcare.

Anyone who has children knows that caring for them is a joy, a privilege, and a responsibility freely taken up. Work is also important. It gives people another sense of purpose, affords the dignity of providing for oneself and a family, and produces tax revenue for the government.

How to balance those things is perhaps the greatest challenge a working parent ever faces. The choices can be wrenching at times. But for government, the answer is simple:

Make childcare tax deductible. Provide a subsidy for those who earn below a certain income. Then stop.

Richard Holden is a professor of economics at UNSW Business School. Twitter: @profholden

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