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The American Families Plan: Too many tax credits for children?

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The American Rescue Plan Act (ARP), which was signed into law by President Biden in March of 2021, provided relief to Americans and businesses suffering from the COVID-19 pandemic. The Act included major reforms to three tax credits aimed at supporting families: the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), and the Child and Dependent Care Tax Credit (CDCTC). The Administration now proposes either to extend those reforms or to make them permanent in the $1.8 trillion American Families Plan (AFP). While these reforms are commendable, they are complicated and may miss an opportunity to rethink what goals we are trying to accomplish with these tax credits, and how best to achieve them. First, three different tax credits leave it up to families to navigate a bewildering set of eligibility rules and benefits. Second, they come with a very high price tag that may not be fiscally sustainable over the longer run without major and politically fraught tax increases. Third, if we are going to spend this much money, we should think carefully about what it will do – not just to reduce child poverty in the short-run, but to expand opportunity and social mobility in the longer run.

Morgan Welch

Senior Research Assistant & Project Coordinator - Center on Children and Families, Economic Studies, Brookings Institution

President Biden has paved the way for bold, new ideas, but now is the time to build back better, to reimagine the system in a way that is simpler, more cost-effective, and easier for workers and families to navigate. For example, in an earlier analysis of various tax credit proposals, Sawhill and Pulliam showed that if the goal is to reduce poverty, a high priority should be to make the existing CTC fully refundable, but taking total program cost into account, nothing can beat the EITC as the best overall way to reduce child poverty. The EITC not only provides subsidies to families with children but, because it encourages work, it also boosts a family’s own earnings and puts them on a path to being self-supporting. Because of its effects on earnings, it leverages taxpayer dollars to accomplish more poverty reduction for the same expenditure of funds (as we show in Figure 2). The fact that the expansion of the CTC (as included in the ARP) reduces child poverty by almost half is impressive but should not obscure the fact that there could be better, more targeted, and more effective uses of the same money. By simplifying existing tax credits, creating strong incentives for work, better targeting the funds to those who need them most, and allocating more to improving children’s longer-term prospects, we might accomplish even more. The President has emphasized that he welcomes new or better ideas for accomplishing these objectives. It is in that spirit that we offer these comments.

THREE CHILD TAX CREDITS AND THEIR PROPOSED EXPANSIONS

The remainder of this brief is primarily devoted to reviewing the three tax credits that President Biden proposes to expand. In addition to providing a primer on these credits, we hope to convince the reader that their complexity is daunting even to the experts, much less to the average family. With most adults now expected to work and a rising proportion being both the primary breadwinner and the sole parent in a family, finding the time to learn about and apply for all these programs could be intimidating. This complexity also leads to high error rates and some fraud, undermining the integrity of the programs. We end with some comments on how the system might be simplified along with some broader questions about the best way to allocate whatever funds are available.

Earned Income Tax Credit (EITC)

The EITC provides extensive subsides, tied to work, to families on the lower rungs of the income distribution. However, it has been long criticized for providing little to no benefits for workers without children. As highlighted in Table 1 below, the ARP included a substantial expansion in the maximum EITC benefit for childless workers from about $500 to $1500. This expansion will help reach more than 17 million low-income Americans, according to the Center on Budget and Policy Priorities. Although these are adults living without children, many are nonresident fathers or are young adults trying to get started in a career that will enable them to form a family. Research suggests the childless benefit will encourage work, although mostly among women and the most disadvantaged men.

TABLE 1

EITC chart

Sources: Income Limits and Range of EITC (IRS, 2020); Estimates of Federal Tax Expenditures for Fiscal Years 2020-2024 (The Joint Committee on Taxation, 2020); House COVID Relief Bill Includes Critical Expansions of Child Tax Credit and EITC (CBPP, 2021); What’s in President Biden’s American Families Plan? (Committee for a Responsible Federal Budget, 2021).

The EITC is the most effective tax credit at reaching those in the bottom of the income distribution. Figures 1a and 1b show the distribution of benefits for the EITC, CTC, and CDCTC pre- and post-ARP for each income group. Even before the passage of the ARP, the EITC was clearly the winner in targeting the bottom two quintiles and remains so with the ARP expansions, with over half of the benefits going to the lowest quintile. It’s also true that the reforms of the CTC at the bottom of the income scale, by themselves, are a very cost-effective way to reduce poverty. There is little merit, on the other hand, to both raising and expanding CTC benefits to higher-income families.

Figures 1a and 1b

Child and Dependent Care Tax Credit (CDCTC)

The CDCTC provides tax credits to families for a portion of their child care expenses. However, it is nonrefundable and thus does not benefit Americans with the lowest incomes. In fact, its benefits are heavily skewed toward families making more than $100,000 a year. As highlighted in Table 2, the ARP would substantially expand the credit by making it fully refundable and by boosting the credit, and the AFP would make these changes permanent.

The AFP contains other supports in addition to the CDCTC to make child care more affordable and improve training for providers. Specifically, child care would be free for low-income families. Families earning up to 1.5 times their state’s median income would pay for child care based on a sliding scale, but no more than 7 percent of their income would go to child care.

In addition, universal pre-k programs would allow parents to remain attached to the workforce during a child’s early years, and help to ease the pressure to balance work and family life. Thus, President Biden’s plan includes multiple ways to make child care available or affordable; the tax credit is just one of them.

TABLE 2

CDCTC chart

Sources: Child and Dependent Care Tax Benefits: How They Work and Who Receives Them (CRS, 2021); Estimates of Federal Tax Expenditures for Fiscal Years 2020-2024 (The Joint Committee on Taxation, 2020); The Child and Dependent Care Tax Credit (CDCTC): Temporary Expansion for 2021 Under the American Rescue Plan Act of 2021 (ARPA; P.L. 117-2) (CRS, 2021); What’s in President Biden’s American Families Plan? (Committee for a Responsible Federal Budget, 2021).

Child Tax Credit (CTC)

Pre-ARP, the CTC was not fully refundable, so it provided relatively fewer benefits to those with little or no income tax liability. It also extended far up the income distribution. Single parents making up to $200,000 and married couples making up to $400,000 received the full credit. While under pre-ARP law, the CTC was partially refundable, many have called for the tax credit to be made fully refundable in order to help those at the bottom of the income distribution. As shown in Figures 1a and 1b above, in 2021 (pre-ARP), about 11% of the CTC’s benefits went to families in the lowest quintile, while nearly 40% went to those at the top of the income distribution, in the fourth and fifth quintiles.

The CTC pre-ARP is much more costly than the EITC, with federal expenditures on the EITC totaling over $67 billion in 2020, as compared to the $112 billion spent on the CTC. The EITC is also much more effective at targeting funds to lower income families. Figure 2 below shows the change in after-tax income pre-ARP, per $100 billion. By adjusting for the cost of the program, it becomes even clearer that the CTC has not been as effective at reducing poverty.

Figure 2

The expansions proposed in the ARP (Table 3) address some of these issues. They make the CTC fully refundable, thereby reaching millions of the very poorest families and substantially increasing the CTC for millions of working-poor families that previously were able to get only a partial, and often quite-modest, credit. The Biden Administration has proposed making the full refundability permanent, an action that has been called for by many experts, and would ultimately make the CTC more progressive and much more effective at reducing poverty. Additionally, under the ARP, the credit is bumped up from $2,000 to $3,600 for children under 6 and to $3,000 for children 6-17 with the benefit starting to phase out at $75,000 for single filers, $112,500 for head of household filers, and $150,000 for joint filers. These changes are expected to reduce poverty by 45%, according to Columbia University’s Center on Poverty and Social Policy.

TABLE 3

CTC Chart

Sources: The Child Tax Credit: Primer (Tax Foundation, 2020); Estimates of Federal Tax Expenditures for Fiscal Years 2020-2024 (The Joint Committee on Taxation, 2020); What is the child tax credit? (Tax Policy Center, 2021); House COVID Relief Bill Includes Critical Expansions of Child Tax Credit and EITC (CBPP, 2021); What’s in President Biden’s American Families Plan? (Committee for a Responsible Federal Budget, 2021).

The ARP was a $1.9 trillion emergency relief bill. The plan was an aggressive response to a pandemic that left Americans without economic security, jobs, and other needed benefits. But once the emergency is over, we should question the merits of a permanent expansion of all of these child tax credits. While the CTC expansion proposed under the AFP has been applauded by many for its antipoverty effects, it is extremely costly. According to estimates from the Committee for a Responsible Federal Budget, the expansion of the CTC could cost $450 billion over the next 10 years, assuming that the expanded benefits amount will only continue through 2025. If the expanded credit amounts, as well, are continued after 2025, we are looking at a 10-year estimate of $1.2 trillion for the program.

IS THERE A BETTER APPROACH?

These concerns about cost, about complexity, about targeting, and about the long-term effects on social mobility, as opposed to effects on short-run poverty, lead us to suggest the following:

  • Expand the EITC. Expanding the EITC as proposed in the ARP to provide more generous benefits to childless workers is long overdue. But increasing the benefit to only $1,500 may not be enough to provide a meaningful reward for work in low-wage jobs. This benefit should be increased to at least $3,000 with related modifications to the rate at which the benefit phases down as earnings rise. This should be combined with an increase in the federal minimum wage – to at least $12 per hour. Families cannot form, much less flourish, as long as the rewards for work remain depressed. Unconditional cash assistance is not a good substitute for an adequate paycheck. Delivering the subsidy as part of the paycheck could have additional positive effects on employment.
  • Reduce Income Taxes. There are simpler ways to support middle-income families with children than offering them complicated tax credits for child care, for raising children, or for other purposes. It’s called base broadening combined with lower tax rates. Instead of offering so many credits, let’s just eliminate income taxes for middle and lower-income families, as proposed by Reeves and Sawhill. This need cost no more than the CTC. Its advantage is simplicity. The losers would be high-income families who currently qualify for the CTC or the CDCTC. The winners would be the middle and working classes that President Biden wants to help. Most families would no longer have to pay any income tax. The refundable portion of the EITC could be raised to a higher level and would, in addition to reducing poverty, offset most payroll taxes. That would be a game changer.
  • Invest in education, including quality child care, Pre-K, and a longer school day. Eliminating the CDCTC but reallocating the funds to the kind of child care subsidies President Biden has already proposed would simplify the system. We don’t need two child care programs, one on the spending and the other on the tax side of the budget. President Biden’s focus on investing in the caregiving workforce also needs additional resources. The problem is not just the cost of child care but the availability of high quality care. Without better teachers and child care workers, children will not thrive in out-of-home care. We could also provide new resources to local communities so they could offer a longer school day and year, making it possible to align school hours with work hours, as proposed in Reeves and Sawhill. Current school hours are obsolete. They were based on an agricultural economy and one in which women didn’t work. Extending the school day and year would greatly lessen the need for child care and could be used to address COVID-19 learning losses or other remedial needs.
  • Evaluate the most cost-effective ways of reducing long-term or intergenerational poverty. The CTC has been widely touted for its ability to reduce child poverty. What this discussion misses is that it’s easy to reduce annual poverty rates if you spend enough money, even if much of that money isn’t going to those who really need it and even if a publicly-financed boost to family income is not necessarily the only or the most cost-effective way to achieve the longer-run goal of reducing persistent and intergenerational poverty. We should ask how an increase in the after-tax income of middle- and upper-middle class families is going to be spent and how that extra spending will improve children’s lives or future prospects. Our colleagues Pulliam and Reeves do a nice job of reviewing the literature suggesting that giving money to lower-income families is not just a good way to reduce short-term poverty but also a good way to improve upward mobility and poor children’s long-term prospects. But before we commit over $100 billion a year to an expanded CTC, we should consider other uses for the same funds such as investments in education, in health and nutrition, in better housing or neighborhoods, in baby bonds, or in better parenting. An exhaustive study by Nathaniel Hendren at Harvard has found that investments in education and health are a more cost-effective way to improve children’s longer-term prospects than are cash transfers. These investments along with making the current CTC fully refundable might be a better use of scarce public resources.

CONCLUSION

The proposals being introduced by President Biden have the potential to dramatically benefit working- and middle-class families, many of whom are struggling to recover from the COVID-19 pandemic, support their families, and invest in their futures. However, we shouldn’t build off of a problematic system. The child tax credits as currently proposed overlap with each other and impose unnecessary administrative burdens on families. Expanding the EITC while making the earlier CTC level of $2,000 per children fully refundable and permanent, and eliminating the CDCTC entirely would free up spending to allow us to invest in long lasting changes, such as universal Pre-K, child health and nutrition, a better child care and teacher work force, afterschool programs and the like. Many will complain that this substitutes public programs for parental choice. We disagree and instead argue that the best way to give parents more choice is to simply eliminate income taxes, at least for all working-class families, and to expand the EITC. President Biden has argued that this is the time for bold action. We should harness this opportunity to transform our system to support working families, by making the tax credits simpler and more targeted to those in need. At the same time, we need to invest in a high-quality education and care infrastructure that serves all families, and not just those with the ability to pay.

Acknowledgments:

The authors thank Robert Greenstein and William Gale for their comments, and Christopher Pulliam for his review and assistance.

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