The introduction and expansion of fully refundable child tax credits in eleven states are a significant positive development in family policy. However, as highlighted in our research, the design choices states make when implementing these reforms can vary in effectiveness, with some approaches proving more beneficial than others:
Most states already have a solid foundation for reform in their existing exemptions and credits. Layering a whole new system of tax credits on top of the existing infrastructure is both expensive and unnecessary. Instead, states can modify what they already have and build on it by converting exemptions into credits and consolidating overlapping exemptions and credits into a single more generous credit.
Several states offer strong examples of how to build on existing foundations. Minnesota transformed its earned income tax credit into a fully refundable child tax credit. Massachusetts replaced a pair of deductions for dependents with two fully refundable tax credits for dependents, later consolidating them into a single, more generous fully refundable credit. Similarly, Maine initially converted its dependent exemption into a nonrefundable child tax credit and subsequently evolved it into a fully refundable child tax credit.
Despite these models of success, other states have faced challenges in implementing comprehensive tax credit reforms. California–an early innovator in converting exemptions into credits–has failed to build on those reforms effectively. Instead, the state adopted a piecemeal approach, layering new refundable credits on top of existing ones without integrating them. This has resulted in a fragmented and inefficient system of tax credits—a disjointed “kludgeocracy” that diminishes the overall impact of these policies on families.
California’s tax credit kludgeocracy
While many states converted dependent exemptions into nonrefundable credits following the Tax Cuts and Jobs Act of 2017, California made this change much earlier–back in 1967. Today, the Dependent Exemption Credit (DEC) is a nonrefundable tax credit for qualifying dependents, including children under 19 or under 24 if they are full-time students. Indexed for inflation, the DEC is worth up to $446 per dependent in 2023.
As a nonrefundable credit, the DEC is of little value to low-income families because they have little or no tax liability left over after claiming the state’s standard deduction and personal exemption credits. Rather than simply converting the DEC into a fully refundable credit as did Maine and Massachusetts, California introduced two additional refundable tax credits in the last decade.
In 2015, California introduced the California Earning Income Tax Credit (CalEITC). While most states set their EITC as a percentage of the federal EITC, CalEITC sets its own parameters which involve multiple phase in/out rates. It is indexed for inflation, worth up to $1,900/$3,137/$3,529 depending on number of qualifying dependents, and limited to families earning less than $30,950 in 2023.
In 2019, California introduced the Young Child Tax Credit (YCTC). Initially it had the same income eligibility at the CalEITC. The earnings requirement was then dropped in 2022. It is indexed for inflation, worth $1,117 for households with children under 6 years old earning less than $25,775 before completely phasing out at $30,932 in 2023.
The sheer number and complexity of tax credits available to families with children can make it challenging to determine eligibility and calculate benefit amounts based on household earnings. Figures 1 and 2 illustrate the value of the DEC, CalEITC, and YCTC for two scenarios: a single parent with one child under six and a married couple with one child under six, based on household earnings.
Figure 1: California tax credits for single parent with one young child
Figure 2: California tax credits for married parent with one young child
The figures highlight the extent to which California’s tax credit kludgeocracy hyper-targets benefits on some low-income families while excluding others without clear justification. In this case, the total value of tax credits peaks at about $6,600 in earnings– equivalent to working one day per week at the state minimum wage of $15.50 per hour.
In contrast, a parent working full-time at the state minimum wage ($31,000 annually) would receive just $59 in total tax credits if single and nothing at all if married. These families earn too much to qualify for the state’s refundable tax credits (CalEITC and YCTC) but not enough to qualify for the full value of the state’s nonrefundable tax credit (DEC). Similarly, a family earning the state’s median or average wage earns too little to qualify for the full value of the DEC.
Evidence from the California Franchise Board indicates that very few families receive anywhere near the maximum CalEITC credit. For instance, while the maximum credit for a family with one child was $1,698 in 2021, the average credit received by qualifying families that year was only $353. Researchers have observed the labor impact of CaEITC is limited, despite its status as the nation’s highest matching rate program. This is because the credit is so narrowly targeted that a full-time minimum-wage worker earns too much to qualify.This helps explain why, as we noted in our 2023 family benefit report card, California has the highest implicit marginal tax rates on moving from welfare to work out of the ten states we examined. The state’s refundable tax credits are recreating the problems of welfare as we knew them before the 1996 reforms.
Time for a more holistic approach
The combined cost of these three tax credits—CalEITC, DEC, and YCTC—is projected to reach almost $2 billion this year. Given California’s fiscal challenges and the poor targeting of each credit, it is difficult to justify increasing the value of any single credit.
A potential way forward would be to consolidate the CalEITC and the DEC into a single, fully refundable tax credit worth $500 per dependent. This would reduce the overall cost of reform, improve targeting, and reduce complexity for families. Figure 3 illustrates the net impact of this reform on single parents with one, two, or three children.
Figure 3: Net impact of replacing CalEITC and DEC with a fully refundable DEC
Because the CalEITC concentrates its maximum benefit on a relatively small subset of parents who work less than half-time hours, the reform would shift benefits to those without earnings and those working at least half-time at the state minimum wage. Given the amount of earnings volatility experienced by low-income families, consolidating and reforming the tax credits would likely benefit them in the long run. Under the proposed changes, the value of the DEC would increase for families in years where they have no earnings, as well as in years when they achieve more consistent earnings through part-time or full-time work.
Transitioning to a universal flat credit for dependents would also help reduce poverty traps that penalize work and marriage. Many low-income parents feel as if they are balancing on the edge of a cliff, where even small increases in their household’s earnings can trigger significant reductions in benefits. California’s tax credit kludgeocracy has created a series of cliffs, complicating the path to upward mobility for families. Any policy package aimed at enhancing support for families must prioritize reducing or eliminating these benefit cliffs to ensure that work and marriage are rewarded rather than penalized.