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Child care subsidies and economic efficiency


             The models established and analysed in this paper represent attempts to highlight the efficiency effects of subsidies to organised day care arrangements in the form of kindergartens. The main motivation for the study has been that the existing literature does not seem to have reached clear-cut results concerning the efficiency effects of such subsidies. Rosen has – as mentioned in the introduction – been critical to the high levels of subsidies that can be found in Sweden and the rest of the Scandinavian countries, but his analyses do not provide insight into how high or low the optimalsubsidy level is.        

            The results described in this paper have shown quite clearly that subsidising kindergartens may boost the efficiency of an economy in which there are preexisting marginal tax rates on labour income. Moreover, the models indicate that the optimal subsidy level can be quite high, around 60% of the gross cost. The main reason for such results is that kindergarten expenditures make mothers’ budget constrains very flat, such that the private incentives to work become very small. Since this group of workers or potential workers also is believed to have relatively high labour supply elasticities, one may use kindergarten subsidies as a screening device as an alternative to tax reforms for this elastic work force, and thereby enhance efficiency. However, it is not a necessary condition for having beneficial efficiency effects from kindergarten subsidies that the supply elasticities among mothers with preschool children are higher than the average worker.

            The fundamental rationale for formalised child care is to allow for specialisation gains or “economies of scale”, since the labour requirement per child is lower in kindergartens than if one mother takes care of her own child or children – of course provided that the mother does not have a too high number of preschool children at the same time. Such a specialisation gain would materialise without government intervention in a first best world where all prices were undistorted. A necessary prerequisite for increased efficiency when introducing subsidies to child care arrangements, is therefore that there are distortionary taxes in the labour market. In countries like Norway and other Scandinavian countries, the total tax rate on labour incomes is quite high, and these high tax rates imply too little specialisation gains and too low female labour participation without government intervention.  

            The main idea behind the development of the model has been to give a reasonably accurate description of the budget constraints and labour supply elasticities of mothers with children of preschool age and of the rest of the Norwegian work force, and the tax and transfer system of the Norwegian economy. All other aspects of the production and consumption pattern are treated in a highly aggregated fashion. The model is therefore hardly a realistic general equilibrium model of the economy as a whole, but hopefully still relevant for the particular issue studied here, namely the labour supply decision of mothers with preschool children, their interaction with the government’s budget in their capacity as tax payers and transfer recipients, and the general equilibrium effects on the labour tax rates for all labour tax payers in the economy. We would not think that adding more detail into the model in terms of more refined consumption and production patterns would lead to substantial changes in our main results. Nevertheless is it doubtful whether a model of this kind is accurate enough to give precise policy recommendations like e.g. to raise the overall subsidy from today’s level to, say, 70 or 80%.

            An obvious caveat of the model is that it represents the labour market as a perfectly competitive market with no involuntary unemployment. This is hardly a realistic description of the economy. We do believe, however, that the main economic mechanisms that make day care subsidies favourable to efficiency within the perfectly competitive framework, would survive also in a setting with unemployment.

            A reasonable conclusion therefore seems to be that there is good reason to keep on with subsidised kindergarten arrangements as a part of a rational economic policy package, and that the optimal subsidy rates from a pure efficiency point of view may be of considerable size, e.g. in the range 50 to 70%. The exact level of the efficiency maximising subsidy level is sensitive to a number of parameters like the wage distribution of mothers relative to other workers, the cost level in kindergartens, the labour supply elasticities of both mothers and other workers in the economy, and how the equilibrium wage rates respond to changes in labour supply among different types of labour.