The National Party has announced a new childcare policy, called Family Boost, which would be implemented if they are elected later this year. As Stuff reported earlier this week:
If the public service stops hiring so many consultants, National Party leader Christopher Luxon says it could afford greater childcare subsidies.
During his State of the Nation speech on Sunday, Luxon promised he would order the public service to cut $400 million from its consultancy bill. That money, he said, would fund a new childcare policy, giving a 25% rebate to most families’ childcare bills.
The childcare rebates were expected to cost about $250m per year and would be available per household – not per child...
National’s new childcare policy, which it calls Family Boost, would give a rebate of 25% on childcare costs up to an annual limit of $3900 for families earning under $140,000. This would mean up to $75 per week to offset childcare costs.
So far, so good. But then:
Luxon dismissed concern that giving tax rebates for early childhood fees would lead to an increase in prices, given the majority of children attend for-profit childcare centres. He said the “really competitive” ECE market would mean prices wouldn’t go up.
”I think early childhood education providers will know that they try and pump up fees, they will lose families,” deputy leader Nicola Willis said.
Both Luxon's statement that a competitive market won't raise prices, and Willis' statement that increasing childcare fees following the subsidy will lead childcare centres to lose families, are very likely wrong. To see why, let's consider a model of the market for childcare services, as shown in the diagram below. For simplicity, let's start with no subsidy in the market. [*] Without a subsidy, the market is in equilibrium, with a price of P0, and Q0 hours of childcare are provided. The subsidy, paid to the families (the buyers in this market), is represented by a new curve D+subsidy, which sits above the demand curve. It acts like an increase in demand, and as a result the price that childcare providers receive for childcare services increases to PP. The families pay that price, then receive the rebate back from the government, so in effect they pay the lower price PC. The difference in price between PP and PC is the per-hour amount of the subsidy. [**] So, our model immediately suggests that Luxon's comment about the competitive market not raising prices is incorrect. It is true that the price doesn't go up by the whole amount of the subsidy - the difference between the original price P0 and the new higher price PP is less than the per-hour subsidy (PP - PC).
Next, the number of hours of childcare services provided increases from Q0 to Q1 (because families want to have children in childcare for more hours because of the lower effective price they have to pay, and childcare providers want to provide more hours of childcare because of the higher price they receive). So, even though childcare services have increased in price, the quantity of childcare services demand has increased. So, our model also suggests that Willis' comment about childcare services losing families is also incorrect.
Of course, the model is not the real world. However, what would it take for a subsidy not to increase prices? If the supply curve was horizontal (meaning that supply is perfectly elastic), then prices would not increase. Perfectly elastic supply suggests that there is a large reserve army of childcare providers at the current market price, just waiting for families to call them for childcare services (in fact, it means that there is unlimited supply available at the market price). Any parent who has tried to find a childcare centre for their child at short notice will know that is not the case (see here, for example). And that is just the tip of the iceberg for problems in this sector, as this Stuff article by Michelle Duff documents.
Subsidies increase prices. That happens when the market is competitive, and when the market is not competitive. I'm sorry Mr Luxon - you can't appeal to the competitiveness of a market to argue that subsidies won't increase prices.
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[*] This assumption essentially doesn't change any of the main conclusions. It just makes the market a bit easier to draw.
[**] The actual amount of the subsidy varies between families, but again that doesn't change any of the main conclusions.
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