Japan’s tax-benefit system includes features that may weaken work incentives for secondary earners. Tax allowances for low-income spouses create a financial penalty for entering employment or increasing earnings as they phase out. Stepwise childcare fees for children under three produce sudden cost increases as household income rises. This note uses the OECD tax-benefit model to assess two hypothetical reforms – removing spousal tax allowances and linearising the childcare fee schedule – and assesses their individual and combined effects on work incentives at both the extensive margin (the decision to work) and the intensive margin (the decision to earn more).
Strengthening work incentives for second earners in Japan
Abstract
Removing spousal tax allowances would reduce disincentives to take up employment and deliver a more stable financial return to work across earnings levels, reducing both extensive and intensive margin distortions.
Replacing step-wise childcare fees for parents with a gradually tapering schedule would make costs more predictable and avoid sudden price hikes in the event of marginal increases in parental earnings.
Both reforms combined produce complementary gains. The childcare reform would lower net costs across the earnings range, narrowing the gap between childcare costs in Japan and the OECD average and strengthening incentives to take up employment for second earners. The spousal allowance removal would amplify the gains at higher earnings levels.
Secondary earners in Japan may face work disincentives from two separate parts of the tax-benefit system. The personal income tax system grants allowances to primary earners whose spouse earns below a given threshold. These allowances decline as the spouse’s earnings rise, creating a financial penalty for taking up work or earning more at the income levels where phase-out occurs. Separately, the public childcare subsidy for children under three uses a stepwise fee schedule, where parental contributions jump abruptly as household income crosses certain thresholds, reducing the net financial return to employment for marginal income increases above the thresholds.
Both features are likely to primarily affect mothers with young children: they are more likely to be the lower-earning partner in a couple and more likely to carry primary childcare responsibilities. The combination of these two features means that for many mothers the financial return to entering or expanding employment could be relatively low. This note evaluates two hypothetical reforms designed to address these disincentives and examines how their effects interact (Table 1).
Japan’s personal income tax system grants relief for taxpayers with a low-income spouse through two closely aligned schemes operating at national and local levels. Each scheme includes a flat-rate tax allowance when the spouse’s earnings are below a threshold (dark blue and grey bars in Figure 1), and a ‘special’ tax allowance that decreases gradually once the spouse’s earnings exceeds that threshold (light blue and grey bars in Figure 1 – see supplementary material for additional design details). Together, the national and local allowances reduce the primary earner’s tax liability.
Because the allowances phase out when the spouse earns more, they create a financial disincentive at both the extensive and intensive margins (Figure 2). At the extensive margin, the phase-out effectively adds to the tax increases and benefit losses a secondary earner faces when moving into work: participation tax rates are therefore higher around the withdrawal range than they would be in the absence of the allowances (Panel A). At the intensive margin, the stepwise withdrawal of the flat-rate allowance generates spikes in marginal effective tax rates at the specific earnings level where entitlement to the flat-rate component ends and the tapered component begins. This creates a non-linear pattern of work incentives that is difficult to anticipate and may discourage some secondary earners from working near or just above the phase-out threshold (Panel B).
Removing both allowances under the national and local tax systems would reduce these effects. The reform would also simplify the income tax system and remove one structural factor behind gender disparities in employment outcomes in Japan.
Participation tax rates (Panel A) and Marginal effective tax rates (Panel B) for secondary earners
Note: Panel A shows the participation tax rate for a secondary earner, by earnings in the new job. The earnings of the primary earner are fixed at 67% of the average wage. The primary out of work benefit is social assistance. Housing benefit top-ups or temporary into-work benefits are not included. Policy reference data: 1 January 2025. Participation tax rates (PTRs) measure the fraction of additional earnings lost to higher taxes and benefit withdrawals when the secondary earner takes up work. Marginal effective tax rates (METRs) measure the fraction of additional earnings lost to higher taxes and lower benefits when earnings increase. Higher PTRs and METRs imply weaker incentives. The supplementary material provides detailed policy rules and an in-depth analysis of PTRs and METRs.
Source: OECD Tax-Benefit Model version 2.8.0.
Childcare in Japan is co-financed by parents. For a child under 3, parental contributions are a stepwise income-based schedule: as household income crosses a threshold, fees for one child jump to a higher level (Figure 3). Fees are reduced for a second child and free for the third. For children aged 3–5, childcare is provided free of charge, with parents covering only meal costs. The stepwise structure creates two problems for work incentives. First, it generates sudden, large reductions in the net childcare subsidy as households move between income bands, which can translate into sharp spikes in METRs at those thresholds. Second, it makes it difficult for families to anticipate the net cost of increasing earnings, as a small additional income gain can trigger a disproportionately large increase in childcare fees.
A linear fee schedule would replace stepwise parental contributions with a smoothly tapering schedule. Fees would rise gradually with income, eliminating sudden cost jumps. The reform is designed to maintain targeted support at low-income levels while extending partial subsidies to higher income levels: support would taper more gradually, so households would retain partial benefit further up the income scale. Net childcare costs would eventually reach the same ceiling (the full national gross childcare fee) but at a higher income level than under the current system, reflecting an extended range of support (Figure 4).
In international comparison, Japan’s net childcare costs would remain above the OECD average after the reform, but the gap would narrow especially for lower-income families (Figure 5). For a couple where one parent earns the minimum wage and the other earns 67% of the average wage, net childcare costs would fall from 13.1% to 8.5% of the average wage, approaching the OECD average of 7.3%. The reduction would be smaller for higher-income families but would remain present across the earnings range illustrated.
At the extensive margin, the reform would improve work incentives by lowering net childcare costs across the earnings range: secondary earners would face lower PTRs (Figure 6, Panel A). At the intensive margin, the reform would eliminate the spikes in METRs associated with stepwise fee thresholds, producing a smoother profile of incentives to increase earnings (Panel B). However, the more gradual phase-out of the subsidy means that childcare support withdraws more slowly at higher earnings levels: secondary earners above the midpoint of the earnings range would see slightly higher METRs than under the current system, as they continue to benefit from a partial subsidy that declines as earnings increase.
Participation tax rates (Panel A) and Marginal effective tax rates (Panel B) for secondary earners
Note: Calculations refer to a one child (aged 2) couple family with the principal earning the average wage. The second parent takes up full-time employment at the earnings level shown. It is assumed that no childcare is used when the second parent is out of work, and childcare services are used full-time when they take up employment. It is assumed that the household is eligible to social assistance. Housing benefits are not included. Policy reference data: 1 January 2025.
Source: OECD Tax-Benefit Model version 2.8.0.
Applying both reforms simultaneously produces complementary but partially offsetting effects on work incentives (Figure 7). At the extensive margin, the childcare reform lowers net childcare costs and reduces PTRs across most of the earnings range (Panel A, dashed green line). The spousal allowance removal compounds this gain for earnings above 32% of the average wage, approximately the level of the hourly statutory minimum wage in a full-time schedule, where eliminating the phase-out of the allowance further reduces the financial penalty of entering work (solid green line).
For part-time work at the lowest earnings levels (below 32% of the average wage), an interaction between the two reforms partially offsets the childcare gain. Because the spousal allowance removal increases the reference income used to calculate parental childcare contributions, it effectively pushes net childcare costs upward, increasing PTRs at these earnings levels. The combined reform therefore provides only a marginal improvement in incentives to take up low-earnings part-time work, while delivering a clearly stronger incentive to take up full-time employment at average or above-average wage levels.
At the intensive margin, the combined reforms reduce METRs relative to either reform applied in isolation, particularly at lower earnings levels (Figure 7, Panel B). The spousal allowance removal eliminates the stepwise METR spikes generated by the phase-out of the flat-rate allowance, reinforcing the smoothing effect of the linear childcare fee schedule. The result is a lower and more stable METR profile across the income range: secondary earners face fewer distortions in their incentive to increase hours or earnings. The gain is most pronounced at the earnings levels previously affected by both the childcare fee thresholds and the withdrawal of the spousal allowance, where the combined effect of removing both discontinuities substantially reduces the effective marginal tax burden.
Participation tax rates (Panel A) and Marginal effective tax rates (Panel B) for secondary earners
Note: Calculations refer to a one child (aged 2) couple family with the principal earning the average wage. The second parent takes up full-time employment at the earnings level shown. It is assumed that no childcare is used when the second parent is out of work, and childcare services are used full-time when they take up employment. It is assumed that the household is eligible to social assistance. Housing benefits are not included. Policy reference data: 1 January 2025.
Source: OECD Tax-Benefit Model version 2.8.0.
Overall, the two reforms are complementary in their design rationale. The spousal allowance reform addresses a tax-side disincentive: it raises the net financial return to work by removing a tax reduction that diminishes as the spouse earns more. The childcare fee reform addresses a spending-side disincentive: it reduces the net cost of using childcare and smooths the income schedule through which costs increase. Applied together, they address the two main channels through which Japan’s tax-benefit system currently penalises secondary earners for working more, while generating work incentive gains that are greater than either reform would achieve alone for secondary earners entering full-time employment.
The supplementary material accompanying this study provides: i) detailed policy rules on spousal tax allowances under Japan’s national and local income tax systems; ii) an in-depth analysis of PTRs and METRs for the spousal allowance reform individually; iii) detailed policy rules on net childcare costs and the Early Childhood Education and Care fee schedule for children under 3; and iv) an in-depth analysis of PTRs and METRs for the childcare fee reform individually.
How do taxes and benefits affect disposable household income, benefit replacement rates, and financial work incentives? Find out using the OECD tax-benefit web calculator.
More information on Japan’s tax and benefit system is available in the OECD Descriptions of Tax and Benefit Systems
Contact: Joanna Mroczka (Joanna.MROCZKA@oecd.org) and Daniele Pacifico (Daniele.Pacifico@oecd.org).
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