Worthy Goals, Flawed Policies — Why Increasing Tax Deductions for Parents Can be Wrong
Tax expenditures (TEs) — also called tax benefits, tax reliefs, or simply tax subsidies — are used widely to pursue different policy objectives, e.g. boosting innovation and R&D, attracting investment and reducing poverty. Governments worldwide forego significant amounts of revenues through the implementation of these provisions. In the US, the fiscal cost of federal TEs was estimated at USD 1.3 trillion, 6% of GDP, in 2019. For the same year, the estimates are less than 1% of GDP in Germany, above 4% in France and more than 3% in Italy.
Tax Expenditures in Switzerland Remain a Blackbox
Switzerland’s most recent Federal Financial Statement reports that the fiscal cost of federal TEs amounts to CHF 20–24 billion, or around 3% of GDP in 2019. Yet, as acknowledged in the report, “the revenue foregone due to TEs is often not estimated” and hence, the accuracy of these figures is questionable. The striking opacity of TEs significantly hinders accountability. It also breaches Switzerland’s subsidies law which takes a clear stance against TEs and requires a review of all financial support measures, including TEs, every six years. Alarmingly, the only official TE report was published in 2011. Its update is thus three years overdue. Equally worrisome, the lack of transparency makes the scrutiny and evaluation of TE provisions particularly hard, and hence opens the door to the implementation of (or expansion of already existing) policies that are not effective.
Supporting Parents with Tax Deductions
The reform to reduce taxes for parents that Switzerland will vote on in a referendum on September 27 is a case in point. The package on the ballot includes two measures: i) to increase the general tax deduction for children from CHF 6,500 to 10,000 CHF, and ii) to raise the tax deduction for third-party childcare costs from CHF 10,100 to CHF 25,000. The proponents support the reform package arguing that it will help parents to face rising living costs and contribute to tackling the shortage of qualified workers by encouraging both parents to remain in, respectively re-enter into, the labor market. Opponents instead, warn against its fiscal cost, estimated at 370 million CHF for the general deduction and 10 million CHF for the targeted support for childcare. They also point to the regressive impact of the package since the benefits would be disproportionally captured by the better-off.
An Odd Choice
Since no evaluations exist on the distributional effect of the general tax deduction based on the current CHF 6,500 threshold, it is impossible to assess precisely which families are benefiting from this provision the most. Yet, for starters, those who do not pay federal income tax — 40% of Swiss households, according to the government — receive no benefit. In addition, tax deductions are a particularly regressive type of TEs since their value is negligible for families with low marginal income tax rates, and significantly higher as income and thus marginal tax rates go up. Spending an additional CHF 370 million a year on a measure that particularly benefits higher-income parents appears to be an odd choice — even more so as the government is dealing with an unprecedented economic shock triggered by COVID-19, which is hitting the poor the hardest. A refundable tax credit, such as the US Child Tax Credit that also benefits those who do not pay federal income taxes, would shift support to those in need. That, however, is not on the ballot next month.
Unlike the increase in the general tax deduction, the cost of increasing the tax-deductible cap for third-party childcare expenses is expected to be relatively low. The reason behind this low estimate are low expectations in terms of impact. Again, 40% of Swiss households do not benefit. For the remaining 60%, if anything, the expected behavioural change in labour force participation (LFP) would likely be limited to families with children that have not yet started compulsory education. Once children enter Kindergarten, private childcare costs are considerably reduced. As a result, the current deduction cap is binding only for a low number of families. In addition, day-care fees in several cantons are highly subsidized, thus again moving the costs of many families into the range that they can already deduct under the current limit. Overall, the effects are expected to be negligible, and the bulk of support is likely to flow to those better-off.
Worthy Goals, Flawed Policies
Supporting families and increasing LFP are goals worth-pursuing, but the package to be voted on September 27 would be a step in the wrong direction. It misses out on supporting those most in need. It is unlikely to trigger meaningful effects in labour markets. And it would be yet another addition to the pile of TEs that Switzerland already has and which run counter to the explicit provision in the country’s subsidies law that TEs are to be avoided.