Are fully refundable child tax credits recreating welfare as we knew it?

One of the most significant state-level innovations in family policy over the past two decades has been the proliferation of fully refundable child tax credits (CTC). New York led the way in 2006 with the introduction of the Empire State Child Credit, offering eligible families a minimum $100 per child if they have little or no earnings. Since 2021, 10 more states have introduced similar fully refundable CTCs. Research on similar credits at both the federal level and internationally has demonstrated positive outcomes for child development and health, as well as significant reductions in child poverty.

Still, some critics argue that fully refundable credits, by being unconditional, risk recreating many of the problems associated with the pre-1996 system of Aid to Families with Dependent Children (AFDC). One of the primary concerns with AFDC was its creation of significant work disincentives, which could trap families in a cycle of welfare dependency. In the early 1990s, social scientists found that a single parent receiving AFDC benefits could face implicit marginal tax rates exceeding 90% if they worked full time at the minimum wage. Under these conditions, it’s easy to see how a rational person might find it nearly impossible to transition from welfare to work, without invoking stereotypes like the “welfare queen.” 

The issue was one in urgent need of reform, and there were several ways to address it to ensure families would be better off working than relying on welfare. Congress and state legislatures generally relied on a combination of reducing AFDC (which was replaced with Temporary Assistance to Needy Families or TANF) benefits and adding new work requirements while increasing the value of the earned income tax credit (EITC) for families with children to “make work pay” for low-income workers. This approach is a well-documented part of welfare reform history. 

Fewer advocates of welfare reform are familiar with how other countries have tackled similar issues. In Canada, for instance, the government took a different approach to what was popularly referred to as the “welfare wall” problem. The federal government, in collaboration with provincial governments, reduced the value of social assistance benefits, which had previously phased out quickly when parents took full-time jobs. To offset this reduction, they expanded federal and provincial fully refundable child tax credits which didn’t begin to phase out until household earnings reached a much higher threshold. Subsequent governments added smaller in-work tax credits to help further “break down the welfare wall.” These reforms successfully reduced reliance on social assistance and increased employment while providing low-income families with additional resources. 

The key to success in both the U.S. and Canada was that policymakers reduced the penalties for transitioning from welfare to work. In the U.S., this was achieved by ensuring that some of the benefits families lost from TANF were offset by the gains they received through the EITC. In Canada, it was achieved by focusing on minimizing the loss of social assistance benefits relative to what families continued to receive in child tax credits as their earnings increased. 

Fully refundable child tax credits in U.S. states, which vary substantially, can replicate the success of Canada’s reforms–if structured effectively. To do so, they must establish relatively high income thresholds that avoid penalizing lower-income families’ economic mobility. One litmus test for determining whether a state CTC recreates welfare as we knew it or as a way to “make work pay” is to assess whether families lose most or all of their state CTC when they transition into a full-time job at the state minimum wage or state median wage. Table 1 categorizes the 11 states with fully refundable child tax credit based on whether families lose most or all of the credit if they work at the minimum wage (low threshold), median wage (medium threshold), or further up the earnings ladder (high threshold). 

Table 1: Fully refundable child tax credit phaseout thresholds

We can illustrate how child tax credits in different states might impact transition from welfare to work by comparing the analogous cases of a single parent with two young children residing in two different Portlands: one in Portland, Oregon and the other in Portland, Maine.

A tale of two cities

As of 2024, Oregon and Maine both have fully refundable child tax credits, a standard minimum wage that applies across most of the state, and a higher minimum wage for their respective city of Portland. 

Oregon provides a fully refundable $1,000 child tax credit for children under 6 years old. It begins to phase out when households earn $25,000. It phases out completely when households earn $30,000, regardless of number of children. The standard minimum wage in Oregon is $14.70/hour but Portland, OR has a slightly higher minimum wage of $15.95/hour. This amounts to $31,900 in annual earnings for a parent working full time. 

Maine provides a fully refundable $300 child tax credit for children under 17 years old. It begins to phase out at a 0.75% rate when single parent households earn $200,000 and married parent households earn $400,000. The standard minimum wage in Maine is $14.15/hour. Portland, ME has a slightly higher minimum wage at $15/hour. This amounts to $30,000 in annual earnings for a parent working full time. 

Figure 1 illustrates what happens when these hypothetical households go from having no earnings to working full time at minimum wage in their respective Portlands. 

Figure 1: Interaction between state minimum wages and child tax credits 

For the family in Portland, ME, there is no change in credit amount: they receive the same $600 until they begin earning more than $200,000. This is similar to the welfare reform approach we saw in Canada. Conversely, the family in Portland, OR, loses their entire credit–essentially leveling a $2,000 penalty for taking a full-time job. This is similar to what we saw under the pre-welfare reform system in the U.S.

Fortunately, parents still have a strong incentive to work, as other refundable tax credits phase in while SNAP benefits phase out more gradually. However, in Portland, Oregon, parents transitioning from welfare to work lose both their TANF benefits and their full state CTC, which increases the work disincentive.

Mo money, mo problems?

Contrary to concerns that providing families with additional economic support will have a large negative impact on child wellbeing, the overwhelming evidence in the literature shows that giving families more resources leads to improved outcomes for children. However, this same literature also highlights that the structure of that support plays a crucial role in either strengthening or diminishing its impact on those outcomes. 

There is some validity to the concern that fully refundable child tax credits can recreate welfare as we knew it – but only in the case of states where these credits begin to phase out at very low thresholds and at steep rates. While these credits, like traditional welfare programs, can certainly reduce poverty, they may also inadvertently create work disincentives. State policymakers can avoid this problem by structuring fully refundable child tax credits as universal benefits for all families or, at the very least, setting phaseout thresholds well above median income levels.