BACKGROUND: This study investigated the incidence of potentially preventable hospitalisations in the first two years of life among children in the National Health Insurance (NHI) system of Taiwan. It also examined income disparities in potentially preventable hospitalisations across four economic categories: below a government-established poverty line and low-, middle-, and upper-income. Five major diseases causing potentially preventable hospitalisations were investigated: gastroenteritis and dehydration, asthma and chronic bronchitis, acute upper respiratory infections, lower respiratory infections, and acute injuries and poisonings. METHODS: NHI data on enrolee registrations and use of ambulatory and hospital care by all children born between July 1, 2003 and June 30, 2004 (n = 218,158) was used for the study. The negative binomial regression method was used to identify factors associated with total inpatient care and the severity level for various types of potentially preventable hospitalisations during the first two years of life. RESULTS: This study found high inpatient expenses for lower respiratory infections for children in all income categories. Furthermore, results from the multivariate analysis indicate that children in the lowest economic category used inpatient care to a much greater extent than better-off children for problems considered potentially avoidable through primary prevention or through timely outpatient care. This was especially true for acute injuries and poisonings and for lower respiratory infections. On average, and controlling for other variables, a child in poverty spent 6.1 times more days in inpatient care for acute injuries and poisonings (p < 0.01) and 2.7 times more days for lower respiratory infections (p < 0.01) before age two, compared with a similarly-aged high-income child. The results also suggest a connection between economic status and the severity of a condition causing a potentially avoidable hospital admission. On average, length of stay for each admission for gastroenteritis and dehydration for children in poverty was 1.3 times that for high-income children (p < 0.01). Both the ratios for lower respiratory infections and for acute upper respiratory infections were 1.2 (p < 0.01 for both). CONCLUSIONS: There were high hospital admission rates and lengths of stays for lower respiratory infections among young children in all income categories. Hospital care use of young children in the poorest category was significantly higher for acute injuries and poisonings as well as for lower respiratory infections, compared with those of better-off children. The findings suggest the need for increased attention to these two disease types. It particularly calls for more research on the causes of high hospital care use for lower respiratory infections and on the reasons for large economic disparities in hospital care use for acute injuries and poisonings.