Child Tax Credits and the Poor: A New Approach

Child Tax Credits and the Poor: A New Approach

In the current issue of National Affairs, I have a lengthy piece (paywalled) about family policy. It addresses a lot of questions -- Does daycare hurt kids? Should child care be tax-deductible? Are families with two working parents overtaxed relative to families where one parent stays home? -- and I hope it will prove worth reading for those who care about such things. But in this teaser, I'd like to flesh out a small point I make late in the essay.

Over the last few years, reform conservatives ("reformicons") have taken up the cause of the child tax credit. To simplify a bit, under current law, parents are given a credit worth up to $1,000 per child age 16 or under, plus a dependent exemption worth about $500 per child. The reformicons say that's not enough: Children contribute to the future health of our society and economy -- especially entitlement programs -- and are more valuable to the government than the current level of tax relief implies. Reformicons would like to expand the credit significantly.

There's a wrinkle in their plan to do this, however. The credit they suggest (an additional $2,500 in Sen. Mike Lee's proposal) can count against both income and payroll taxes, but beyond that it's not "refundable" -- that is, if a parent doesn't pay at least $2,500 in taxes to begin with, that parent won't get the full credit. Since the logic behind the credit is that raising a child should count as a $2,500 contribution to the public fisc, these parents are essentially overpaying their taxes and not getting the money back.

But as the economist Robert Stein, who authored a Room to Grow chapter about the credit, has pointed out, there's a wrinkle in the wrinkle too: People who make so little money that they won't get the full credit often qualify for poverty programs -- and poverty programs themselves act as a sort of child credit, giving more benefits to families with more children. Over the course of a year, a family with one child can receive nearly $3,000 more from the Earned Income Tax Credit than a family with no children, for example. And expanding a household by one person increases the maximum food-stamp benefit by around $150 a month.

Stein defends the reformicon proposal on the grounds that it holds poor families harmless while giving middle-class families tax relief, and he points out that giving even more benefits to the poor could encourage irresponsible childbearing (especially when those benefits are explicitly conditioned on recipients' having children). Liberal critics, most prominently Matt Bruenig, suggest a fully refundable credit (delivered in the form of a monthly child "allowance") layered on top of existing poverty programs.

I say we should go a third route: Why not make the child credit completely refundable, but then cut poverty spending on parents to compensate, seeing as this spending has been made redundant? Not only would this make the expanded child credit more intellectually coherent -- a child counts as a tax contribution of $2,500, and if you overpay you get your money back, period -- but it would help to address a major problem with poverty benefits.

As countless analysts across the political spectrum have pointed out, means-tested programs often have very high implied tax rates: As the poor make more of their own money, their benefits are quickly taken away. This means that pursuing economic opportunity -- taking on more hours, getting a better job -- isn't as rewarding as it should be. In rare circumstances, someone who gets a raise can even lose money.

This is a very tricky problem to solve. You can cut benefits for the very poorest so that they have less to lose as they make more, but that's not a particularly nice thing to do. Or you can take benefits away at a slower rate as income rises, but this costs money, and it involves giving people taxpayer dollars above and beyond what they need to support themselves.

The beauty of a fully refundable child tax credit, therefore, is twofold. First, it is not a welfare payment but a reflection of the value that parents provide, so there's no problem with giving it to families that don't need it to make ends meet. And second, it simply stays the same as a family's income changes -- it won't be pulled out from under poor parents as a punishment for working hard.

Importantly, this approach would also largely address conservatives' concerns about further subsidizing irresponsible childbearing decisions. Ideally, a poor family that's eligible for the maximum amount of poverty relief would face the exact same incentives it faces today, except that some of the money would come from the child tax credit instead of means-tested benefits. (However, for some families the child tax credit would inevitably be worth more than the benefits it replaced, simply because poverty relief phases out and the child credit would not.)

In short, this idea would make the child tax credit more than just a way to reduce taxes for middle-class parents. Made fully refundable, with some poverty relief cut to compensate, the credit would properly account for the contributions of parents regardless of their income -- and it would give poor parents a smoother route into the middle class.

Robert VerBruggen is editor of RealClearPolicy. Twitter: @RAVerBruggen

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