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Child Care Tax Credits: A Supply-Side Success Story
LEADING PROPOSALS BEFORE CONGRESS
In the last session of Congress, as many as 100 bills relating to children or child care were introduced, and in the current session child care has again become a major political issue. The two proposals that have received the most national visibility are (1) the Bush Administration proposal, advanced principally by Senator Robert Dole (R-Kansas), and (2) the ABC proposal, advanced principally by Senator Christopher Dodd (D-Conn.)
The Bush Administration Proposal. President Bush has proposed a child care credit up to $1,000 per child for families with children under age four.24 The proposal differs from the current child care tax credit in two ways. First, the credit would apply only to families earning less than $13,000 in 1990 and less than $20,000 in 1994. Second, the proposal would require that only one adult in a two-parent family work, and would not require evidence of out-of-pocket child care expenses. Thus, the proposal really amounts to an increase in the after-tax income of low-income families with children rather than tax relief for day-care expenses.
Both these departures from the current system are also departures from a sound supply-side strategy. By limiting the credit to families with low incomes, the proposal ignores the fact that higher-income families presently generate much higher revenue returns. By making the credit available to two-parent families regardless of whether the mother works and irrespective of actual child-care expenses, the proposal would encourage low-income mothers to quit work.
The Bush proposal purports to be pro-traditional family and is strongly supported by the mothers-should-be-home-with-their-children lobby.25 The reality is quite different, however. As a practical matter, very few two-adult families have an annual income less than $13,000. The proposal initially would have virtually no impact unless it succeeded in separating single mothers from their children by inducing them either to enter the labor market or to remain there. Once the threshold reaches $20,000, more two-parent families would be affected, but with negative supply-side effects. The greater the number of women in two-parent families who remain at home, the lower the national output and government revenue.
The Bush Administration would not reduce the current child care tax credit available for middle-income families. But the decision to create a different kind of tax credit for low-income families represents a major break with the supply-side philosophy of the Reagan Administration.
The ABC Bill. The approach favored by many Congressional Democrats -- embodied in the Act for Better Child Care bill (ABC) -- is to create a new government spending program. Although the Senate bill was amended many times to appease different constituencies, its original purpose was clear -- to create federal subsidies for day-care centers and to subject these centers to federal regulations.
The watered-down and frequently-amended version -- recently passed by the Senate -- provides for $1.75 billion per year in spending and another $2 billion per year in three types of refundable tax credits.26 The $1.75 billion would be given to state governments to spend with the requirement that 70 percent of the funds27 be used for families below the state's median income. 28 The funds would not necessarily be restricted to day-care centers.
Because the bill gives enormous discretion to state governments, no one can be certain what the program's specific effects will be. However, we do know that spending under the ABC bill will differ from the current "tax expenditures" for child care in two important ways:
1. Whereas the tax credit puts funds directly in the hands of parents, under the ABC bill these funds would be filtered through state bureaucracies already influenced by the day-care lobby. Although the bill allows states to create vouchers that would permit parental choice, this provision is deceptive. First, the ABC bill does not require states to create vouchers. Second, even if states do create vouchers, parents will be able to use them only at officially approved day-care centers. If the sponsors of the bill really wanted to empower parents rather than the day-care bureaucracy, they would simply have liberalized existing tax credits.
2. Whereas the tax credit treats equally all families with the same income, there is no such provision in the ABC bill. Under the bill, the state may choose beneficiaries according to unspecified criteria.
These two departures from current policy mean that there is no guarantee of a supply-side response from the $1.225 billion spending in subsidies under the ABC bill. For example, a very likely outcome is that parents with children already in day-care would be first in line. Since the $1.225 billion in direct subsidies (70 percent of the $1.75 billion) would not be nearly enough to satisfy all claimants,29 it is quite possible that none of the money would go to parents whose children are not now in day-care. The result: no additional women in the labor force and no government return on the $1.75 billion.
The other extreme possibility is that the subsidies would be distributed in much the same way tax credit dollars are allocated. For example, suppose that 100 mothers apply for subsidies, 90 of whom work and have children in day-care and 10 of whom do not. Suppose also that the state government can fund only 40 percent of the applicants and funds 36 mothers with children already in day-care and four potential working mothers. In this extreme case where the subsidies go proportionately to both sets of families, the subsidies would have much the same supply-side effect as tax credits. However, because only 70 cents on the federal dollar would reach parents, the subsidies would have only 70 percent of the supply-side effect of current tax credits. And remember: this second scenario is the most favorable to the ABC approach. The reality is likely to be somewhere between the two extremes. If instead the $1.75 billion were used to expand the current tax credit, GNP would increase by as much as $3.68 billion and government would get at least half of the funds back in work-related taxes.
One way to compare the ABC bill to tax credits is by its effects on the federal deficit.
- A reasonable prediction is that the spending under the Senate version of the ABC bill would increase the federal deficit by at least $1.4 billion.
- The same impact on the deficit could be achieved by increasing the current child care tax credits by $3.9 billion.
- This $3.9 billion would double the child care credits available to all working families
TABLE VI
PROGRAMS THAT HAVE AN EQUAL IMPACT
ON THE FEDERAL DEFICIT
| Senate | New | |
|---|---|---|
| ABC Spending* | Tax Credits | |
| Total Spending/Credits: | $1.75 billion | $3.9 billion |
| Addition to Federal Deficit: | $1.4 billion | $1.4 billion |
| Direct Benefit for Families | $1.2 billion | $3.9 billion |
| Addition to GNP | $1.1 billion | $6.6 billion |
| New Jobs | 91 thousand | 570 thousand |
| House | New | |
| ABC Spending** | Tax Credits | |
| Total Spending/Credits: | $2.5 billion | $5.5 billion |
| Addition to Federal Deficit: | $1.9 billion | $1.9 billion |
| Direct Benefit for Families | $1.75 billion | $5.5 billion |
| Addition to GNP | $1.5 billion | $9.4 billion |
| New Jobs | 130 thousand | 814 thousand |
*Assumes that ABC spending of $1.75 billion would add $1.4 billion to the federal deficit --calculated by assuming 70 percent of funds go to day-care subsidies, that subsidies have one-half the effect of tax credits on the employment of women and that tax credits generate 65 cents in new government revenue per $1 of credit. The 65 cent estimate is the mid-point between the high and low estimates of government revenue return per dollar of tax credit after removing the effect of state and local income taxes.
**Assumes that ABC spending of $2.5 billion would add $1.9 billion to the federal deficit -- calculated under the same assumptions as in note. *
INCREASING THE SUPPLY OF DAY-CARE SERVICES
One argument to justify federal subsidies to day-care centers through the ABC bill is that there is a shortage of day-care services. Those making this argument overlook four important points:
1. Over the last decade there has been an explosion of home-based, women-owned businesses. As many as 23 million Americans are currently doing some work at home.30 Although both men and women are turning to homework with increasing frequency, women run most small home-based businesses. Currently about 63 percent of all sole proprietorships in the U.S. are operated from private residences, and more than 70 percent of them are managed by women. 31 Given the ease with which women begin home-based businesses and the success they have operating them, the market should have no problem supplying any quantity of day-care services consumers demand.
2. Arbitrary government regulations are keeping many qualified day-care providers from offering their services to working mothers. State and local licensing laws, zoning regulations, anti-homework laws, and many other regulations depress the supply of day-care services. Often, these regulations impose arbitrary and impossible-to-meet restrictions on providers -- restrictions that bear little relationship to the issue of "quality."
3. Because of arbitrary government regulations, many day-care operators provide services illegally and are therefore not counted in official estimates of the supply. It is estimated that as many as 80 percent of day-care providers who operate in their homes are unlicensed. In many cases these providers are operating illegally, although their customers are presumedly satisfied. When "caught," they simply shut down rather than attempt to deal with the regulatory bureaucracy.32
4. The ABC bill would greatly expand the number of government regulations, creating an even greater "shortage" of day-care services. Although ostensibly designed to encourage the supply of day-care services, the ABC bill would actually discourage potential suppliers. The bill encourages states to enforce existing licensing requirements and create new ones. It would also create a new layer of federal bureaucracy, paving the way for federal regulations and controls.
The following is a brief summary of the obstacles faced by consumers and producers in the market for child care services.
State licensing laws often impose arbitrary restrictions on the number of children per day-care provider, the number of square feet of playing space per child, etc. Although adopted for the ostensible purpose of maintaining "quality," these laws serve a more sinister purpose. They are often the result of pressure from the day-care lobby in its attempt to keep businesses and people operating out of their homes from competing with the organized day-care industry.
In one case, a company in Berkeley, California, wanted to set up a day-care facility for its employees. Among other things,33
- The company was told that its facility could not share any common ground with the rest of the building -- a separate entrance, separate bathrooms and a separate kitchen were required.
- California's licensing law also required 35 square feet per child inside the building and 75 square feet outside.
The first set of requirements conflicted with Berkeley's local zoning ordinances and the second was impossible to meet in an urban setting. The result: the company abandoned its plans for a day-care facility.
and Other City Regulations
A host of laws at the local level constitute a formidable barrier to would-be day-care providers. Currently, about 90 percent of all U.S. cities place restrictions on home-based work. These include requirements that no outside employee may work in the home; that only one family member may work in the business; that only one business may be operated from each home; that only one room of a house may be used for business purposes; that a separate entrance must be maintained for business customers; and that no business inventory may be stored in a garage. Among the many and sometimes bizarre regulations:34
- In Blaine, Minnesota, a home-based tutor in math, English or a foreign language may not tutor more than one student at a time.
- In Long Beach, California, ministers, priests and rabbis may not give religious instruction in the home.
- In Dallas, home-based businesses may not be listed in the yellow pages of the telephone directory.
- In Downey, California, a garage may not be used for home-based work.
- In Rockford, Illinois, there can be no more than one home occupation in any single residence.
- In Chicago, there is virtually a total ban on home-based work, including a ban on connecting a home computer to an office computer.
Unless state law specifically overrides these ordinances, they apply to day-care as well as other businesses. For example, local officials told a California woman that to operate a day-care facility in her home, 35
- She had to have separate bathrooms for teachers and for children, commercial rather than household locks on her doors and a commercial thermostat in her refrigerator.
- She had to get the approval of 14 neighbors in nearby homes.
- No child could arrive before 8:00 in the morning or remain beyond 5:30 in the afternoon
The special interest lobby for the day-care industry usually argues that government regulations are needed to ensure a minimum quality of care. All too often they shamelessly play on public fears about sexual abuse of children -- fears heightened by a few recent scandals. Yet the regulations seldom relate to the problem. Even a fairly straightforward regulation can backfire:36
- A criminal record check can prevent a well-qualified woman from operating a day-care facility because she was caught with a marijuana cigarette in her youth.
- Yet this type of regulation did not stop a Colorado day-care operator previously acquitted of sexual abuse charges on grounds of insanity.
Advocates of regulation often forget that the only real advantage a government agency has over an individual family is in gathering certain types of information about the suppliers of day-care services (credentials, training, record of service). Once the information is gathered it can readily be shared with consumers. A regulatory agency -- possibly in a distant city and with far less motivation -- is at a distinct disadvantage in gathering the types of information that is best obtained by parents making frequent visits and on-site inspections.
By certifying standards, a government agency may be able to help parents make better-informed choices. But, once the information is shared, there is no argument for substituting the judgment of bureaucrats (far from the scene and subject to political pressures) for the judgment of parents.37