Today, the credit covers almost 60 million children and 35 million families. Many other OECD countries offer a child tax credit, either to all families or to those below a certain minimum income. Alternatively, families with at least three children can get a refund up to their entire payroll tax liability not already offset by the Earned Income Tax Credit EITC. This expanded refundability was extended for two years in and further extended through at the beginning of this year.
Of that total, slightly more than half is spent on refunds to taxpayers who have no tax liability. The Tax Foundation estimates that if the Child Tax Credit was eliminated and the revenue was used to reduce rates, all tax rates could decrease by 4. It boosts after-tax incomes for the bottom 40 percent of taxpayers by 1. Since it provides a flat per-child benefit, an upper-income household sees a smaller percentage change in income.
The top fifth of taxpayers only see a 0. Because of income phase-outs, the top 1 percent generally do not benefit from the child tax credit. If the expansion expires as scheduled at the end of , taxpayers in the bottom quintile would lose most of their benefit, though those in the second quintile would retain much of their benefit and taxpayers in the top 60 percent would see no change.
In terms of the distribution of the benefit of the child tax credit, more than three quarters of the benefit goes to the bottom sixty percent of the income spectrum, including about 22 percent to the bottom quintile and almost 30 percent accruing to the second quintile. The wealthiest fifth of taxpayers receive less than 5 percent of the benefit. Proponents of keeping or expanding the child tax credit argue that a family should be held harmless for the costs of having children, an equity goal the credit helps to achieve though some argue it does not do enough and some argue it already overcompensates.
Some suggest the credit accomplishes a laudable and fiscally important goal by encouraging people to have more children. Finally, proponents argue that the child tax credit, along with the earned income tax credit, provides crucial support for low-income families. Opponents of the child tax credit argue that children should not be subsidized by the government and such favoritism in the tax code is inappropriate.
A number of options exist to reform the existing Child Tax Credit. Ultimately, the CTC lacks efficiency in part because it is duplicative in aim and contradictory in benefit eligibility, overlapping with other credits that suffer from the same issues. Ideally, the tax code should not encourage or discourage personal or business decisions, but instead should be neutral with respect to the decision-making process.
However, there is also a question of whether a household with two workers and no children should pay the same taxes as a larger household with two workers and two dependents, all else equal. There are several considerations to discuss when evaluating what treatment is neutral.
In terms of having an effect on economic growth, the CTC is negligible, as these competing effects on labor decisions work to cancel each other out. The federal individual income tax is structured so that those who are lower-income pay little to no tax, and it contains provisions that work to increase the disposable income via refundable tax credits.
The credit offsets burdens in other areas, such as the payroll tax and sales taxes, which fall heaviest on lower-income taxpayers i. On a more mechanical level, the CTC acts as a buffer to the escalating effective marginal tax rates [37] filers experience as the EITC benefit declines:.
The original phase-in range for the CTC was pegged to coincide with the end of the phase-in range for the EITC for families with at least two children to address concerns over high marginal tax rates for families receiving the EITC.
Overall, the CTC helps lift families with workers and dependents out of poverty, significantly helps those in lower- to middle-income groups i. Despite their distinctives, the central point of each credit is identical: reducing tax liability, thus offsetting regressive provisions of the code and, in some cases CTC and EITC , providing more disposable income for saving or consumption.
Yet, there are overlapping and duplicative elements common to each credit, which raises the question for reform: how could each credit be adapted to accomplish its respective goals while maximizing efficiency, reducing compliance and administrative bandwidth, and providing needed relief to those who need it most?
It is, however, designed to provide lower-income families the means to be more productive and independent. Assisting families with their dependents through a child tax benefit increases the likelihood that parents will enter and continue in the labor force, thus retaining the means to consume and save, both of which aid the economy in both the short and long term. Further, children will eventually take the place of their parents in the labor force, supplying the income on which payroll and income taxes will be levied in order to pay for social services e.
More work is needed to reform these three separate child credit-related tax provisions toward efficiency and societal stability. While there are significant drawbacks of administering a child tax benefit through an annual tax return based on taxable income and tax liability, policymakers should pursue the most efficient version of the benefit which supports children, parents, and the economy overall.
The Child Tax Credit reduces tax liability for parents with dependents and assists families in escaping poverty. The current maze of child-related tax benefits makes filing season difficult for parents and the IRS as taxpayers contend with eligibility requirements, differing definitions, income phaseouts, and refundability thresholds.
An ideal tax code should strive for simplicity, neutrality, transparency, and stability. While it is practically impossible to achieve all four principles simultaneously, any reform to the CTC should strive to at least reduce complexity and ensure stability. While a variety of proposals suggests making the credit more generous to parents at lower income levels through various mechanisms, the overall objective of the credit is clear: reducing tax liability for parents and providing more disposable income for consumption and saving.
Ideally, a consolidation and clarification of the current child-related tax credits would lead to a more transparent, simple, and stable tax code which provides certain tax offsets for work and others for claiming dependents. As policymakers and scholars anticipate the expiration of various provisions under the TCJA in , the CTC will remain a central part of the debate about how the code should treat parents and their dependents.
See Margot L. In part, this is because over the last 50 years the value of the dependent personal exemption has declined in real terms by over one third. See also Margot L. See Id. It is determined by adding the statutory rate to several other factors, e. This also could include any local and state taxes e. Maag, et. See note 35 above for citation. The report's authors acknowledged that there were provisions in the tax code meant to address the increased financial burden to families that arose from having children, specifically the exemption for dependents.
The dependent exemption was intended to provide economic relief to families with children by reducing taxable income by a fixed amount per dependent, and hence reducing tax liability. However, the amount of the exemption was fixed in nominal terms i. Specifically, the commission noted that the dependent exemption, similar to a tax deduction, provided greater monetary benefit to taxpayers with greater taxable income since its value in terms of tax savings was proportional to a taxpayer's highest marginal tax bracket.
And since the dependent exemption could not lower the tax liability of taxpayers who, due to low income, owed no federal income tax, it was unavailable to many families with children who the commission believed most needed economic assistance.
Three years later, in , a child tax credit was included in legislation meant to enact key principles of the Contract with America, a list of policy proposals released by the Republican Party before the midterm elections. In response to the legislation that had been drafted in Congress, President Clinton proposed his own child tax credit during the th Congress in his Middle Class Bill of Rights Tax Relief Act of The credit amounts were indexed for inflation.
An eligible child was defined as being under 13 years of age. After they did not reach an agreement in , Congress and President Clinton revisited the topic of a child tax credit in A key distinction among the proposals centered on the interaction of the child tax credit with the EITC, which would have an impact on the availability of the child tax credit to lower-income taxpayers.
President Clinton proposed the application of the child tax credit before the application of the EITC. For many low- and moderate-income taxpayers, claiming the EITC before the nonrefundable child tax credit reduced or eliminated their child tax credit. By contrast, claiming the nonrefundable child credit before the EITC allowed the taxpayer to claim the full amount of the child tax credit they were eligible for and did not change the value of their EITC. The child tax credit proposals differed in other ways, notably the interaction of the child tax credit with the child and dependent care credit, the age of a qualifying child, and the income phase-out levels and phase-out rates.
Given that the child tax credit was part of a broader tax bill that had to meet budget rules, many of the specific details of the provision were likely agreed upon after evaluating their budgetary impact. What emerged from the conference negotiations that year was the Taxpayer Relief Act of P.
The credit was refundable for taxpayers with three or more qualifying children and was calculated as the excess of a taxpayer's payroll taxes over their EITC the alternative formula.
Neither the credit amount nor the phaseout thresholds were indexed for inflation. The refundable portion of the credit was reduced by the amount of the taxpayer's alternative minimum tax AMT. In addition, this act allowed personal nonrefundable credits including the child tax credit to fully offset a taxpayer's regular income tax liability in In addition, for tax years and , the act included a provision which allowed taxpayers to use their personal nonrefundable credits including the child tax credit to not only offset their regular tax liability in full, but also their AMT.
Finally, the act also extended for tax years through the prior-law repeal of the provision that reduced the refundable portion of the child tax credit by the AMT. Fourth, the law temporarily repealed the prior law provision that reduced the refundable portion of the child tax credit by the amount of the AMT. These direct payments were distributed based on information contained on taxpayers' income tax returns.
WFTRA also contained a provision that allowed combat pay to be included as part of earned income for purposes of computing refundability of the child tax credit. As more soldiers began to see combat due to the wars in Iraq and Afghanistan, they started receiving combat pay. Income earned by members of the armed services in a combat zone is generally excluded from taxation. This exclusion benefits taxpayers who have positive tax liability and reduces the taxes they owe.
However, for some lower-income members of the Armed Forces, the exclusion resulted in earnings being too low to qualify for the refundable portion of the child tax credit. The inclusion of combat pay as earned income for purposes of calculating the refundable child tax credit under WFTRA meant that the earnings of some military families would increase above the refundability threshold, ultimately resulting in larger child tax credit refunds.
This change was for through , and was scheduled to expire, along with other provisions of EGTRRA, at the end of In early , Congress began to debate different legislative proposals for economic stimulus. Part of that debate concerned changing the refundability threshold of the child tax credit.
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