08/01/2013 07:31 GMT | Updated 10/03/2013 05:12 GMT

The Coalition's Childcare Policy Moves in Mysterious Ways

There may have been few details in Monday's renewal of Coalition vows but one key policy continues to invite debate: the government's plans for childcare. It does now seem clear that the government hopes to use tax relief as its key way of reducing childcare costs.

There may have been few details in Monday's renewal of Coalition vows but one key policy continues to invite debate: the government's plans for childcare. Much remains uncertain but it does now seem clear that the government hopes to use tax relief as its key way of reducing childcare costs. While Coalition wrangles continue about the distributional impact of this choice, it now seems likely this will mean a shift of priorities away from Labour's focus on tax credits and universal free places for preschool kids. And if new tax reliefs are worth £2,000 per child as briefing suggests - roughly twice as large as those in the current system - a relatively big change may be in the offing.

As I wrote in December, tax relief is regressive and wasteful at the best of times, let alone when money is so tight. The childcare tax relief that is available today through childcare vouchers is barely used by low income households, gives little extra help to those on middle incomes and helps richer households most of all: around half of all beneficiaries are in the top fifth of income. This isn't a coincidence; it's what tax relief looks like, not least because it gives no help to people who earn too little to pay tax. Even so, there remain some big unknowns about the government's new approach that will be vital in deciding how much it really helps those on low and middle incomes.

The big one is how it's paid for. With briefing suggesting that new funding will come from within the childcare budget - i.e., not really new money at all - this is doubly important. While much of the funding for any new support will likely come from repurposing the £700m already spent on childcare vouchers, far more is likely to be needed - perhaps twice as much. As the pain of earlier childcare cuts continues to bite, it's vital that there aren't further reductions in support through tax credits or further stretching of funding for the preschool childcare offer. It's one thing to spend money in ill-targeted ways but quite another to switch support from lower to higher income households while so many are on the edge - the government wouldn't be forgiven for that.

Beyond funding, though, the other big question is one of design. This really matters because it decides who wins from the new system and, in particular, whether people on tax credits share in the benefits. Broadly the government has three choices, coming down to who administers tax relief.

The first option is to ask individuals to claim tax relief by filing tax returns, reporting their childcare spending and getting tax back at the end of the year in similar fashion to the self-assessment required of the self-employed. It's not implausible that the same could work for childcare. But with the Chancellor still enduring a headache from shambolic Child Benefit reforms, it hardly seems likely that he's about to ask millions more parents to fill out complicated tax forms. That's not to mention the nightmarish issue of working out who lives with who in order to make sure households get the right level of support, or indeed of deciding what kind of spending qualifies - do we really want to give tax breaks for nannies?

The second option is to extend childcare vouchers, leaving employers to sort out the admin. Back in December this seemed to be the frontrunner not least because vouchers already exist and are popular. The Chancellor could simply raise the £55 weekly limit on childcare vouchers (£28 for higher rate taxpayers), letting people take more of their salary tax free to pay for childcare - giving £2,000 of help would mean roughly doubling the limit. As a downside, that would mean pumping more money into a system we already know is even more regressive than tax relief needs to be (in part because vouchers give little extra help to people on tax credits and in part because the employers that offer them - and many don't - tend to be higher paying). Yet with government briefing now suggesting that all parents will get the new £2,000 of help, all employers would need to be required to offer vouchers. Again, that's not implausible but it wouldn't come easily to a government that's anti-red tape, particularly for small business.

That leaves a third option: asking childcare providers to claim the tax back themselves. This would mean asking providers to submit claims to HMRC to top up their income from UK taxpayers. The hope would be that they'd then pass on the gains to parents in lower prices. If it worked, the upside would be lower prices for all taxpayers, including people on tax credits (although technically, and perversely, not the lowest paid). But that raises a big question: would providers really reduce their prices? We already know the UK childcare market is broken. And with so many providers struggling financially, there's a risk that they would take the new money simply to stay afloat. Perhaps ways could be found to require providers to pass on the gains, regulating prices. But then why not simply build on the current offer for two, three and four year olds?

As yet it's far from clear which - if any - of these options will be taken up. Given the harsh distributional implications of tax relief, internal Coalition debates continue. Yet the truth is, whichever option the government chooses, this has all arrived at a rather strange place. That's not to say we should simply continue the UK's current approach to childcare; there are good reasons for not just channelling extra support through complex tax credits. But if you want a universal way to help parents that is widely used by the middle-classes as well as lower income families, is popular and that sits naturally with an attempt to regulate prices, we already have one in the existing preschool offer. Extending that and making it a clearer guarantee to parents would be better policy - and, if the alternative is tax relief for providers, with little promise of lower prices, paid for by scrapping a popular policy of vouchers - it may even be better politics too.