Kindergarten for Free?! Empirical Evidence on the Utilization of Income Tax Deductions for Child Care Expenses

In most developed countries there exist ample possibilities for individuals to minimize their personal income tax burden by means of tax deductions. The associated revenue losses for the government have been estimated for a variety of tax deductions. However, relatively little is known about the share of eligible taxpayers who actually use these deductions, and, more specifically, about what determines utilization. The present paper tries to shed some light on this question in the context of the tax deductibility of expenses for child care in Germany. Using survey data on actual child care expenses and official tax-return data on deductions for child-care expenses, we derive utilization rates. We also analyze the determinants of utilization among those who filed a tax-return, using a subsample of the tax-return data. Our estimation results show that (potential) tax breaks from utilization are significantly positively correlated with the probability of utilization. Other kinds of deductions are also highly significant, suggesting that knowledge of tax statutes as well as opportunity costs matter. Moreover, we simulate the effects of a policy reform that enhances the generosity of deductions on the utilization rate. Such a reform would substantially increase utilization. Our results indicate that responses in utilization are more important than potential responses in labor supply. (JEL codes: D14, H24, H43).