Tuesday, August 18, 2015

Are We Kidding Ourselves About the Effectiveness of the Child Tax Credit?

The cost of raising children seems to increase ever higher. CNN posted an article last year saying that it costs an average of $245,000 to raise a child, which says nothing of the cost of college. This hits hard for those who cannot afford the cost of raising children, which brings up the question of poverty amongst children. The people over at the Left-leaning Center for American Progress (CAP) came up with an idea to help alleviate child poverty: expand the Child Tax Credit (CTC).

A question to start off: what is the CTC? The CTC is a flat-dollar tax benefit offered to help offset the costs of child rearing that has been part of the United States tax code since 1997. Essentially, one can receive a deduction of up to $1,000 per child. Since it is a flat-dollar tax, the tax is relatively progressive since families with lower incomes experience a larger percentage change in after-tax income. Under the Obama administration, the CTC was made more refundable, which is to say that it is easier for those who do not owe taxes to receive the tax credit. Now that we have a brief description of the CTC, is it a good idea?

First, there is the matter of the fiscal cost of the tax credit. As I illustrated when criticizing other tax breaks during this past Tax Day, this tax credit costs $57B per annum. This would make it the country's sixth largest tax break, according to the Joint Committee on Taxation. It is estimated to cost $550B over the next ten years. The Treasury Inspector General also found in 2011 that over a five-year period, the IRS experienced $4.2B of costs in fraud from unauthorized workers claiming credits under the CTC. It's a fraud rate somewhere slightly below 2 percent, but it's still worth pointing out.

Can there be an argument that the benefits justify the costs? Although one can argue that having children is a blessing, it is still a choice to incur more expenses. People make choices to incur more expenses all the time. Why should we favor families with children over those who do not? Is the government the proper authority to determine how many children we should have? Doesn't that defeat the idea of horizontal equity in the tax code? Does the EITC, along with state and local tax codes, not already incentivize enough child rearing?

But wait: there is the argument of social costs. By implementing the CTC, one increases the external benefits to society. The Center for Budget and Policy Priorities claims that it has protected 3.1 million children from poverty. I feel skeptical about that claim since it is very likely that the CTC does not provide the short-term consumption stimulus that one would expect (Michel and Ahmed, 2012). Plus, the phase-out threshold of the CTC could very well disincentivize work (see study [Raschke, 2012] in which that took place for working males in Germany after their child credit was enacted). While economic theory would tell us that a subsidy would lead to greater consumption of something (e.g., raising children), the truth is that there is very little substantive research on how the CTC affects taxpayer behavior, especially since it is simultaneously acting in concert with the Earned Income Tax Credit (Congressional Research Service [CRS], p. 8).

The CTC is a departure from "conventional" policy practices since it does not distinguish between family size or socio-economic status. It is a tax exemption that has cost a half trillion dollars over the past decade and needlessly complicates the tax code (CRS, p. 9) in some attempt to subsidize the act of raising children. We should be weary of a CTC expansion, and at the very least, the CTC could use some reform: Make uniform the definition of a child for the CTC as one who is 19 or younger, lower the benefit received from the CTC, reduce computational complexity by offering more uniform benefits (especially since complexity of the tax code with the CTC makes it more difficult for lower-income households file for the CTC), or make the tax non-refundable.

Removing the credit without an offset in taxes would be politically unsavory. According to the Tax Foundation, if the CTC were eliminated and the revenue were used to reduce rates, we would see tax rates decrease by 4.8 percent. We could follow Canada's example and implement a Tax-Free Savings Account (also known as a universal savings account). If the payroll tax makes raising more children burdensome, à la Marco Rubio, then let's reform the payroll tax. We could come up with all sorts of policy reform that indirectly affect the cost of raising families, whether we're talking about feel-good environmental policy that causes energy prices to skyrocket, employer-sponsored health insurance, or Social Security and Medicare. I would be a fan of reforming the tax code so that we can incentivize economically productive activity. That way, Americans, regardless of whether they choose to raise children or not, can better afford to "live the American dream."

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