Negative Externalities in Day Care: Optimal Tax Policy Response

Abstract

Systematic pediatric evidence shows that the morbidity rates for children in day care are increasing in the group size. Sick children are usually cared for at home by parents. This creates a negative externality of parents&#39 labor force participation. The social optimum implies lower group size than the non--intervention market equilibrium. We study the optimal tax policy. The cost of labor force participation should be increased. This can be done by either or both tax on day care services and a home car allowance. The cost of providing day care should be decreased by a subsidy to entrepreneurs running day care centers. This policy will decrease the group size. It is, however, not necessarily the case that this will decrease labor force participation.