The child tax credit, first enacted in the Taxpayer Relief Act of 1997, allows taxpayers to claim a credit against their federal income tax liability for each eligible child. To qualify, the child must be 16 or younger at the close of the tax year, and the taxpayer must be able to claim the child as a dependent. The credit phases out for single filers whose adjusted gross income is more than $75,000 and for joint filers whose income is above $110,000. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and other laws increased the credit from $500 to $1,000 per child. Most recently, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312, referred to in this report as the 2010 tax act) extended the $1,000 per child credit through 2012. Starting in 2013, however, the credit amount will return to its pre-EGTRRA amount of $500 per child.
The child tax credit is partially refundable, which means that families whose income tax liability (before the credit is applied) is less than the total amount of the credit may receive all or at least a portion of the credit as a payment. Before 2001, only taxpayers with three or more children were eligible for a refundable child tax credit, and the refund was limited to the amount by which their Social Security taxes exceeded the earned income tax credit, or EITC. (The earned income tax credit is a fully refundable credit designed to supplement the wages of low-income families.) EGTRRA made the credit refundable for taxpayers with one or two children and also introduced a new formula for computing the refund. Under the new formula, the refund could not exceed 15 percent of the taxpayer's earned income above an established threshold. That threshold was initially set at $10,000 in 2001 and indexed for inflation; but it has been temporarily reduced to $3,000 by legislation several times over the past few years. Although smaller families must use the newer method to calculate the refundable credit, taxpayers with three or more children can choose the method that yields the larger refund. Beginning in 2013, with the expiration of the 2010 tax act, the criteria for receiving refunds will revert to those in effect before 2001: Only taxpayers with three or more children will be eligible for a refund, which in turn, will be limited to the amount that taxpayers' Social Security taxes exceed their EITC.
Starting in 2013, the first variant of this option would eliminate the portion of the child tax credit that is refundable. The second variant would eliminate the child tax credit altogether. The first approach would reduce the deficit by $11 billion from 2012 through 2016 and by $27 billion over the 10-year projection period; the second would reduce the deficit by $48 billion from 2012 through 2016 and by $117 billion from 2012 through 2021.
One argument for curtailing or eliminating the child tax credit is that other features of the individual income tax--such as the standard deduction for heads of households, personal exemptions, the dependent care tax credit, and the EITC--already provide significant tax preferences to families with children. (For example, a typical single parent with two children is projected to receive up to nearly $5,300 from the EITC in 2013.)
Moreover, the credit does not benefit many of the poorest families because they have no income tax liability--when the credit reverts to its pre-EGTRRA form in 2013, only a handful of taxpayers with three or more children will be eligible for a refundable credit. (Even under the provisions of law that will be in place in 2012--specifically, as outlined by the 2010 tax act--a household's earnings will have to exceed a minimum threshold to be eligible for the refundable credit.) Another argument for the option is that having children represents a family's decision about how to spend its income--a choice that could be considered analogous to other decisions about spending.
Either alternative would also simplify the tax code. The phaseout of the child tax credit at higher income levels requires taxpayers to complete a separate worksheet and perform additional computations. The computation of the refundable portion of the credit for families with three or more children is particularly complex. If policy- makers believe that some families do not receive sufficient assistance through the tax system, then a simpler way to provide benefits would be through expansions of the other child-related tax benefits.
An argument against reducing or eliminating the child tax credit is that the other preferences in the tax code may not fully compensate families for the extra costs of raising children. And eliminating the portion of the tax credit that is refundable, in particular, would limit compensation to those families least able to bear those additional costs. Raising children is an investment that may benefit all of society when those children become productive adults. With additional resources, parents could invest more in child rearing and benefit society as a whole. Those social benefits could take many forms, such as a better educated and more productive workforce, a healthier population, or a more civically engaged electorate.