Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 0729: Should day care be subsidized?

David Domeij () and Paul Klein ()
Additional contact information
David Domeij: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Paul Klein: Institute for International Economics, Postal: Stockholms universitet, SE-10691 STOCKHOLM, Sweden

Abstract: In an economy with distortionary taxes on labor, can subsidies on day care, financed by an increase in taxes, raise welfare by encouraging women with small children to work? We show, within a heterogeneous-agent life-cycle framework, that the Ramsey optimal policy consists in equalizing consumption/leisure wedges over the life cycle and across agents. A simple way to implement this is to make day care expenses tax deductible. Calibrating our model to Germany, we find that tax deductibility for day care expenses leads to an approximate doubling of labor supply for both married and single mothers with small children. The overall welfare gain from optimal reform corresponds to a 1.0 percent increase in consumption.

Keywords: Female labor force participation; Germany; day care subsidies

JEL-codes: E13; J13

43 pages, June 11, 2010

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