Two Simple Ways for Congress to Improve the Child Tax Credit
The Senate tax reform bill, which passed through committee last Thursday, makes significant improvements to the Child Tax Credit (CTC) but still falls short of providing working families with genuine tax relief. Fortunately, the Senate bill contains sufficient resources to enable a restructuring of the CTC without crowding out other priorities, like business tax reform.
As it stands now, the Senate bill doubles the CTC to $2,000 — a notable improvement over the earlier proposal of $1650. However, this is roughly the increase that will be needed to fully offset the loss of the personal exemption for middle income families and to reverse credit erosion from past inflation. The refundable portion is increased a mere $100 to $1,100, phased-in at a rate of 15 percent on income over $2,500. This means the reform provides limited benefits for lower income working families, and actively harms some larger middle income families. Meanwhile, the thresholds for when the credit begins to phase-out are proposed to increase from $110,000 and $75,000 for joint and single filers, to $500,000 for both.
Below are two simple suggestions for how the current Senate bill can be improved.
1) Reduce the phase-out thresholds
Extending the CTC to upper-income households is expensive. According to the latest JCT score, the full reform to the CTC costs an average of $62 billion per year over the first five years. The score doesn’t break down how each change to the CTC contributes to the total cost, but it’s possible to approximate. Under current law, the CTC is fully phased-out for all households at incomes of $150,000. The Current Population Survey indicates there are roughly 6 million households with children under the age of 18 and with incomes between $150,000 and $500,000. Virtually all of those households would be able to claim the full $2,000 per-child credit. Assuming these households average 1.5 children, extending the CTC phase-out thresholds to $500,000 likely accounts for over $18 billion per year, or roughly 30 percent of the reform’s total cost. This estimate is conservative given that many households beyond $500,000 would receive a partial per-child credit along the 5 percent phase-out range as well.
For comparison, there are roughly 4 million households with children under the age of 18 and with incomes below $20,000. If the Senate tax bill is amended to reset the CTC phase-out thresholds closer to current law, up to $18 billion could therefore be recycled back into credit size increases and improvements to refundability. A floor amendment to reduce the thresholds is likely necessary, anyway, as the Senate’s decision to set the phase-out threshold to $500,000 for both married and single filers inexplicably introduces a severe marriage penalty.
There is a constant tension between the desire to extend a program up the income scale in order to strengthen its political constituency, and to target expenditures more narrowly on lower income households in order to get the greatest bang for the buck. Nonetheless, the existing thresholds for the CTC are already more than twice median household income, delivering benefits to 80 percent of all households with children. Extending the phase-out thresholds higher will simply make future credit size increases more costly. If lawmakers have a specific reason for targeting a benefit to the $150,000 – $500,000 income group, it is best addressed by adjusting rates directly.
2) Improve per-child variability
The CTC is often referred to colloquially as the “per-child” tax credit; however, for many lower income families, this is a misnomer. Indeed, without changes to refundability, increases in credit size alone make the term even more misleading. For example, under current law, a household with $15,000 in family income is eligible for the full $1,000 credit for its first child, an additional $800 for the second child, and zero dollars for the third child and beyond. Doubling the size of the refundable credit makes the same family eligible for a $1,800 credit on the first child, with zero additional benefits for the second or third child, thus eliminating the credit’s already limited per-child variability.
Under the Senate bill, however, the refundable portion of the CTC remains capped at $1,000, meaning families at this income level would see no change in their credit, anyway. Yet limited per-child variability remains an issue for many middle income households, as well. This is why analyses of the Senate tax bill have tended to find the biggest losers are middle income households with large families. This is a major source of consternation for pro-family conservatives and anti-poverty advocates alike, as well as for constituents of states with large families on average, like Nevada and Utah.
The only way to ensure the CTC remains a true “per-child” tax credit is to enhance refundability. This means increasing the maximum refundable credit to the full $2,000, eliminating the minimum earning requirement, and adjusting the phase-in rate with the number of children. For example, the CTC could be reformed to phase-in starting at the first dollar, and a rate of 15 percent for the first child, 30 percent for the second child, and 45 percent for the third child. With this structure, a household with $15,000 in family income would receive the full $2,000 credit per-child for the first three children. Per-child variability for middle income households would also be preserved.
Structuring a refundable credit along these lines has a strong precedent in the Earned Income Tax Credit (EITC), which already varies both its maximum credit and phase-in rates with the number of children. However, it would make a great deal of sense from a simplification perspective to give the two credits a more explicit division of labor. The CTC would capture all per-child variation, thereby allowing the EITC to function as a child-neutral wage subsidy, while simultaneously making the CTC more pro-work. A reform along these lines is probably a necessary prerequisite for more ambitious EITC reform proposals.
The tax bill produced by the Senate dedicates roughly $64 billion per year toward expanding the CTC. However, more than 30 percent of the total cost goes to expanding the CTC to upper-income households who have never before received the credit. By keeping phase-out thresholds closer to current law, more dollars could be recycled into greater refundability. By increasing the refundable portion of the CTC to $2,000, starting the phase-in at the first dollar, and varying the phase-in rate with the number of children, working families will become unambiguous net-winners from tax reform.