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Study: Household tax break didn't improve employment or reduce tax evasion

The tax deduction tends to benefit high-income earners, a new study suggests.

Klaara Services Oy:n palveluohjaaja Niina Kaskela
Finland's Tax Administration offers tax credit deductions for the acquiring of household services such as cleaning, renovations and child care. Image: Jari Kärkkäinen/ Yle

A study into a household tax credit deduction offered by Finland's Tax Administration has found that the initiative is not achieving either of its stated objectives, and is instead disproportionately benefitting high-income earners.

In Finland, the Tax Administration offers tax credits for household expenses such as cleaning, child care and home renovation, and the popularity of the deduction is growing. Finland’s tax office estimates that it grants about 400 million euros of credits every year for household deductions.

The purpose of the credit is to improve employment in the sectors covered by the deduction--such as child care and cleaning--and also to hamper the 'grey economy', which is defined as a part of any economy that is neither taxed nor monitored by either national or regional government.

However, a new study by the Institute for Economic Research (VATT) and the Labour Institute for Economic Research (PT) suggests that the household deduction meets neither objective.

The research team used extensive registration data to examine how the introduction of the tax credit and its significant changes have affected the demand for deductible services, and thus employment.

"In our study, no effect on demand was observed in relation to the household deduction, from which it can be concluded that it has no effect on employment," VATT’s research professor Jarkko Harju said. "When the register data was used to examine the effects on the grey economy, it is found that there was no effect on reducing tax evasion either."

Lower price did not increase demand

Firstly, the study examined the effects of the household tax credit deduction in both Finland and Sweden.

The introduction of the deduction in both countries did not significantly impact the demand for related services, the study found, even though the deduction has been quite extensively used.

In other words, the demand for renovations or home cleaning did not increase, even though the household deduction offered clients a tax advantage and therefore a lower price.

"The price does not seem to be very important for how much those services were in demand," Harju said.

At present, the price of work done at home or in a holiday home can be reduced by 40 percent for tax purposes, up to a maximum of 2,250 euros.

Grey economy not affected

Furthermore, the household tax credit deduction had been intended to reduce tax evasion: in principle, the right to deduct encourages consumers to report their purchases to the taxpayer, which in turn increases the pressure on companies to avoid 'grey economy' gigs.

However, this assumption is not supported by the results of the study, and hundreds of millions of euros in tax revenue may have been lost to the state every year instead.

For example, the study found that the introduction of the tax break in Sweden in 2007 did not lead to an increase in sales as reported by cleaning companies to the tax authorities. From this, the research team concluded that the share of the grey economy did not decrease despite the introduction of the tax credit.

Story continues after the photo.

Jarkko Harju,tutkimusprofessori, Valtion taloudellinen tutkimuskeskus
VATT’s research professor Jarkko Harju. Image: YLE
"If the household deduction had the effect of reducing the grey economy, then the amounts reported to the taxpayer would increase. But we do not see any increase," Harju added.

In Finland, the maximum deduction was significantly increased at the beginning of 2009, from 1,150 euros to 3,000 euros. However, this change did not lead to an increase in reported turnover reported from household service companies to the tax authority, according to the study.

"Our results do not support the assumption that a household deduction is an effective way to reduce the grey economy," the study summarised.

Strongly benefitting high-income earners

Despite the findings of the study, some people do benefit from the household deduction as about one-fifth of Finnish taxpayers take advantage of the benefit every year.

However, the study found that the use of the credit is strongly income-based, meaning that the credit particularly benefits high-income taxpayers, who have the opportunity to make maximum use of the deduction.

Low-income workers are less likely to use household services and are therefore not able to take advantage of income tax deductions to the same extent.

"This is an income transfer for those high-income people who use this deduction. They benefit from the fact that they now receive services at a cheaper price thanks to the household deduction system," Harju explained.

Cleaning company: "Incredible" research result

Kaisa Tipuri, CEO of home cleaning company Klaara Service, told Yle that she could "not believe her ears" when she heard about the main results of the study. In her experience, Tipuri said, the merits of a household deduction are undeniable.

"This sounds absolutely incredible. Without a doubt, employment will improve. Today, customers are well aware and know how to calculate that by using the household deduction, they get the service at the same price as they would get on the black market," she said, adding that the credit has been central to the success of her company, which will soon turn 15 years old.

Story continues after the photo.

Klaara Servicen toimitusjohtaja Kaisa Tipuri
Klaara Service CEO Kaisa Tipuri. Image: Jari Kärkkäinen/ Yle

Support in Parliament for raising deduction

In a poll of politicians conducted by Yle last October, the majority of respondents wanted to increase the amount of the household deduction.

Broadly, those most skeptical about raising the deduction were in the parliamentary groups of the governing parties, especially the Left Alliance and the Social Democratic Party.

On the other hand, representatives of the governing Swedish People’s Party and a number of opposition parties were unanimous in their support for increasing the deduction in the survey.

In particular, the opposition National Coalition Party demanded the reversal of a decision made at the beginning of the current government’s term of office to reduce the deduction.

At that time, the maximum deduction amount was reduced from 2,400 euros to 2,250 euros and the compensation percentage decreased from 50 to 40 percent. The government calculated that the change would increase the state's tax revenue by almost 100 million euros.

Harju said he understands why increasing the household deduction sounds like a good idea.

"Perhaps this also shows that there has been no previous research. It is easy to see that there could be such effects in principle, but our research shows that there are no such positive effects on employment," Harju said.

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