Political Economy of Subsidized Day Care

In a simple model of day care enrollment and labor supply, we have shown that in countries like Sweden where wages are taxed at about 60\%, the government's tax revenue, net of day care subsidies, is likely to be maximized with subsidies covering more than half of day care costs. In contrast, in countries where the marginal tax rate on wages is about 40\%, the subsidy rate that maximizes net government revenue is likely to be between 15\% and 30\%. We also studied the workings of day care subsidies in a federal system. If both federal and local governments collect income taxes and if day care subsidies are set locally, then the subsidy rates chosen by selfish voters in local elections would be lower than the rates they would choose for federal subsidies. In this model all voters are better off if day care subsidy rates are set by the federal government, with voters simultaneously deciding the rate for the entire federation.