Study: Tax credit for household expenses not effective in increasing employment or discouraging grey economy
In its spring 2021 budget session, the Government will discuss possible plans to expand the tax credit for household expenses. However, a new study shows that the tax credit is not an effective means to increase employment or prevent tax evasion.
Every year, more than EUR 400 million is granted in tax credits for household expenses in Finland. Tax credits for household expenses are generally considered an excellent way to increase employment in the service sector and to discourage tax evasion. However, according to a recent study by the VATT Institute for Economic Research and the Labour Institute for Economic Research, the tax credit for household expenses does not significantly contribute to either of these objectives. Tax credits are also disproportionally granted to people with high incomes.
Tax credit for household expenses has little impact on consumption habits
Using extensive register data, the study examined how changes in the system of tax credits for household expenses affect the demand for services in Finland and Sweden. The study found that introducing or expanding the scope of tax credits did not increase the consumption of services.
“According to the study, the tax credit for household expenses seems to benefit mainly those consumers who would have used the services in any case. Because the tax credit does not increase the use of services, it does not generate new jobs in the service sector either,” says VATT Research Professor Jarkko Harju.
Changes in tax credits for household expenses therefore have little impact on consumption habits.
“Our research shows that when using services, consumers are not very sensitive to changes in prices. This finding is in line with earlier studies on the effects of reduced VAT rates on the demand for services,” says Research Director Tuomas Kosonen from the Labour Institute for Economic Research.
According to the study, the recipients of tax credits for household expenses earn significantly more on average than other taxpayers. The higher a person’s income taxes, the more they can take advantage of the tax credit, which particularly benefits high-income taxpayers.
Details of tax credit system not well known
The minor impact of changes in the tax credit for household expenses on consumption habits is also partly explained by the fact that consumers are not very familiar with how the tax credit system works. As part of the study, a survey was conducted to determine consumers’ knowledge of the rules related to the tax credit for household expenses.
“Examining taxpayers’ declarations related to the tax credit revealed that many applicants declare a smaller amount on their tax return than they could. There were also surprisingly few respondents who knew the maximum compensation for household expenses or the correct rate of reimbursement,” says Junior Researcher Sami Jysmä from the Labour Institute.
Another idea behind the tax credit system is that if consumers report the purchase of services to the tax authorities, companies will be more likely to report their sales to the tax authorities rather than resorting to the grey economy.
“However, the sales reported to the tax authorities by businesses in the cleaning sector did not increase with the introduction of the tax credit. We were surprised to see that the tax credit did not have the effect of reducing tax evasion,” says Researcher Aliisa Koivisto from VATT.
The ‘Impact of the tax credit for household expenses on employment and the grey economy’ study was carried out as part of the implementation of the Government’s 2019 plan for analysis, assessment and research.
Jarkko Harju, VATT Institute for Economic Research, tel. +358 40 304 5507, firstname.lastname@example.org
Tuomas Kosonen, Labour Institute for Economic Research, tel. +358 40 940 2336, email@example.com