Supporting children and incentivizing employment: The future of the Earned Income Tax Credit and the Child Tax Credit

Executive summary

Over the past several decades, the social safety net has been reoriented towards providing economic support for low-income families through the tax code. Refundable tax credits, meaning those that can yield a payment even if the tax filer has no tax liability, have largely supplanted monthly cash welfare transfers and are now among the largest federal tax expenditures. The Earned Income Tax Credit (EITC) operates as a wage subsidy for low-income workers, with most of the benefits going to families with children. The Child Tax Credit (CTC) is a credit for families with children except those with very low and very high incomes. Combined, the credits can yield transfers of $10,000 or more for some families.

The EITC is not a pure “work credit,” nor is the CTC a pure “child benefit.” Both phase in with earnings and have maximum benefits that increase with family size. Thus, the two credits serve dual functions: incentivizing work and supporting children. The credits also serve overlapping populations: the vast majority of families with children receiving the refundable portion of the CTC also receive the EITC, and vice versa. The structure of the combined EITC and CTC are shown in the figure below.

It is sensible to assess the intersection of the two programs and outline how they might be designed to meet their twin goals of promoting work and reducing material hardship. In principle, separating them into a worker credit and a child credit could yield more simplicity in the tax code, could boost resources to workers without children who currently receive very little, and could reduce error rates induced by misassignment of children to adults. Several existing proposals – including one from the Aspen Economic Strategy Group, one from the Niskanen Center, and one proposed by then-Senator Romney – have moved in this direction. Our report identifies strengths and weaknesses in each of these proposals. However, none of these examples fully separate the credits.

Here we assess the possibility of a fully separate worker credit (which does not depend on the presence of children) and child credit. The full separation plan is designed to limit the number of households made worse off relative to the status quo and to alleviate hardship among low-income individuals. Achieving these goals becomes quite expensive relative to the benefits achieved, however. We ultimately conclude that smaller reforms to the existing structures could yield many of the benefits at lower cost and less political risk.

Specifically, the following changes would yield improvements at more modest cost: (a) adopting the primary caregiver standard such as that proposed by Niskanen, which would designate an adult eligible to claim a child at birth, (b) improving the targeting of the CTC by expanding the amount available to low-income families and phasing out the benefit sooner, and (c) expanding the EITC for childless workers.

The EITC and CTC have become cornerstones of the U.S. safety net for families with children as well as core elements of the income tax system more generally, achieving twin goals of promoting work and alleviating poverty. With some modest reforms, policymakers can help the CTC and EITC achieve these goals more effectively.

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