Childcare tax rules are too complex

What is holding back mothers who want to work from re-entering the workforce or working extra days after having children? Most Australians will tell you it's because of childcare. Well, to be more specific, the availability of quality, affordable and flexible childcare.

This is a part of the problem, but it doesn't stop there.

Burried on page 745 of the Productivity Commission's Draft Report on Childcare and Early Learning is some of the most telling analysis you will read.

Not only does it highlight the complexity of Australia's tax and transfer system, but it illustrates just how significant a disincentive to workforce participation the interaction of different elements can create.

As any parent will say, the emotional and other non-financial disincentives to return to work, or work extra days, are steep enough without piling on financial disincentives.

Impact of reforms on subsidies

The analysis was included to canvass how the commission's proposed reforms to government childcare subsidies would affect different types of families and their decisions to work between one and five days a week. But, just as importantly, it shows that changes to childcare arrangements alone won't fix a significant problem.

The commission has highlighted that, in 2012-13, over 70 per cent of families who used approved early childhood education and care services also received at least one other government payment. Data supplied by the Department of Human Services showed that, on average, families received more than four types of payments.

The commission steps through eight different example families. Let's consider a few.

Take single mother Nicola and her two- and three-year-old children. Nicola earns $31.54 per hour, and sends her children to long-day care at a cost of $88 per day each.

On top of thinking about providing for her family, Nicola has to think about how working will affect her eligibility for the parenting payment, family tax benefit part A, the childcare benefit and the childcare rebate. And of course, she has to think about the personal income tax system.

11.5PC Tax Rate

The commission's analysis shows that Nicola faces an effective marginal tax rate of 38.6 per cent in working a solitary day. The effective marginal tax rate to work the second day rises to 66.5 per cent, and to 76.3 per cent for the third. But that's not it; the killer is the rise to 111.5 per cent for day four. At that point, Nicola is financially better off to stay home rather than work.

The commission also considers a scenario involving Andy, Rachael and their two children aged six and three. Andy works full time and earns $78,000 per year; Rachael earns $21 per hour. Given the ages of their children, Andy and Rachael need to use both long-day care and outside-hours care.

As Rachael thinks about the financial implications of working, she confronts an effective marginal tax rate for working a third day of over 70 per cent. The drivers? Partial loss of family tax benefits (parts A and B), and the payment of income tax and the Medicare levy.

Then there is an unnamed cameo family, whom I'll call Steve, Sarah and their three-year-old daughter Sally. Steve earns $70,000 per year; Sarah earns $42 per hour and has a HELP debt from university.

Sarah's effective marginal tax rate stays relatively flat for the second and third day of work at just over 40 per cent. However, it rises sharply for the fourth day to over 70 per cent due to the phasing out of childcare assistance (the cap on the childcare rebate is reached), and because she will pass the income threshold to start making HELP repayments.

Struggling to keep up with all the numbers and the drivers? Imagine how mothers juggling work and children feel as they try to work out whether it makes financial sense to increase their days at work! This complexity is reason enough to look at serious, system-wide reform. The perverse outcomes make the case irrefutable.

The Productivity Commission review is an essential step towards a better childcare system. But if you care about removing disincentives to workforce participation for women, the tax white paper may yet prove to be the most important game in town.

Author: Lily Lockwood

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