Welfare Enhancing Marginal Tax Rates: The Case of Publicly Provided Day Care

There is a well established case for public provision of certain private goods when the government pursues income redistribution under asymmetric information about the skill levels of the agents of the economy. This paper higlights the role of tax funding of day care for children, which is a striking example of a valid case for public provision. We demonstrate that the optimal income tax should face alla agents with the (social) cost of the day care they need in order to earn futher income. In this sense day care should not be subsidised. It is simply paid for via the tax bill. However, such a payment scheme, rather than a day care fee, is crucial for alleviating the self-selection constraint of the asymmetric information, non-linear income tax model, as it imposes a burden of paying for superfluous day care on a mimicking high-skilled agent. Also, deviating from conventional preference assumptions, we show that heterogeneity of preferences for work and day care does not invalidate the Pareto improving properties of this kind of public provision.