(Post revised to reflect new law and some errors.)
Senator Mitt Romney (R-UT) has broken with one of the fundamental tenets of conservative economics and politics by proposing a new, expanded Child Tax Credit in his American Family Act (AFA). The novel feature of his proposal is that cash assistance would not be conditional on employment. A similar proposal from the Biden Administration that has been enacted into law is equally a landmark for Democrats, who have historically been defensive about “welfare.” There are also reports of a new proposal that will be put forward by Senator Bernie Sanders (I-VT) and Rep. Rashida Tlaib (D-MI).
All these plans should be welcomed for their ground-breaking nature.The plan of this paper is as follows. First, we describe the credits focused on in this paper – the Child Tax Credit (CTC), the Additional Child Tax Credit (ACTC), and the Earned Income Tax Credit (EITC), as well the related filing status for unmarried parents who file as Heads of Households. Then we compare Biden and Romney proposals to old 2020 law and to each other. An issue that emerges with respect to the Romney plan is the treatment of single parents. Other important details of the plans are beyond the scope of this note.
Tax-Based Benefits for Children
The Federal Individual Income Tax provides several benefits to families with children. Besides the CTC and EITC, they include the Additional Child Tax Credit, the Dependent Care Tax Credit and the “Cafeteria Flex Spending Benefit.” The latter two are beyond the scope of this analysis. Important, related benefits that were eliminated in the Tax Cut and Jobs Act of 2017 were the personal and dependent exemptions. These are scheduled to revive after 2025.
The CTC was popularized as part of the 1994 “Contract with America,” led by then Speaker of the House Newt Gingrich (R-GA). It was enacted in 1997 and provided a reduction in individual income tax liability. Since then, it has been expanded and came to provide a cash “refund” over and above any income tax liability through the Additional Child Tax Credit (ACTC). (“Refund” could be seen as a misnomer, since income taxes are not actually being refunded. In an indirect sense, the refund could be said to offset payroll tax liability.)
The refund is phased in with the taxpayer’s labor earnings, so it is conditional on employment. While it benefits taxpayers with children in the bottom half of the income distribution, it misses those with very low incomes.
The Earned Income Tax Credit (EITC) was first enacted into law during the administration of President Gerald Ford. It began as a “refundable” credit also contingent on earnings. It increases in value with increases in earnings and number of children (up to three) and phases out altogether at higher income levels. Like the CTC, the EITC is not available to those with zero earnings.
President Biden and Senator Romney have both proposed to provide the CTC on a fully refundable basis at all levels of income below $200,000, although under the new law (the Biden plan) the credit phases down to $2,000 per eligible child for incomes of $112,500 and $150,000 for heads of households and married couples, respectively. For most taxpayers, the CTC does not vary with filing status, except in the sense that it is unavailable to those filing single, who have no dependents.
After describing the Biden and Romney plans, we note a problem raised by the Romney scheme: the treatment of single parents. As noted at the outset, both Biden and Romney propose to provide a fixed credit depending on the number and ages of eligible children. Both provide a larger credit for children under age six. For income levels under $200,000 , the credits do not phase out.
The virtue of a fixed credit is that it is higher as a share of income, the lower one’s income, so it serves the objective of tax progressivity. Moreover, in both plans, it is provided irrespective of tax liability. In this respect, it is a marked improvement over 2020 law for families whose incomes are very low, or who have no income at all. It amounts to a “child allowance,” a long-standing goal of liberal social welfare policy.
The absence of a phase-out for most taxpayers means that there is no benefit reduction from earning more money. Such a reduction is understood as an increase in the taxpayer’s marginal tax rate, unlike a “means-tested” benefit that is winnowed away with growth in income. Eliminating a benefit phase-out reduces the taxpayer’s marginal tax rate.
On the other hand, the elimination of a benefit phase-in increases the taxpayer’s marginal tax rate, relative to current law. However, one would be hard-pressed to find a taxpayer who resented such a marginal tax rate increase, since it also means that notwithstanding very low or zero income, they receive a no-strings credit worth thousands of dollars a year for each eligible child.
In general, the preoccupation with marginal tax rates is founded on a dubious view of labor supply – namely, that it is solely a decision by the individual worker. The availability of decent-paying jobs is ignored. The extent to which marginal tax rates actually affect individual decision-making is also debatable.
Another feature of a fixed credit is that it does not change with the taxpayer’s filing status or number of children, so it could be said to be marriage neutral. (Romney’s child benefit entails a partial exception, since it is limited by an annual cap that could affect families with more than three children.)
The first figure below compares the total CTCs for tax year 2021 under old law, and under the Biden and Romney proposals. Both the Biden and Romney credits are reflected in the horizontal line. For children under age six, both the Biden and Romney credits would be bigger, and Romney’s would be bigger still than Biden’s. As we will see below, the greater amount of Romney’s CTC for children under age six offsets some contrasting disadvantages of his plan in certain cases.
The greatest impact of both credits is on taxpayers with less than $40,000 in annual income, including the very poorest. Under current law, both the CTC and EITC reduce poverty. The Biden and Romney plans reduce it further.
The benefits of the Romney CTC are substantially reduced by other “pay-for” provisions in his plan, included for the sake of deficit neutrality. (With a Democratic president, it’s time again to get worried about the national debt.) For purposes of this discussion, the relevant pay-fors are a reduction in the EITC and the elimination of the head of household filing status. The latter pertains mostly to unmarried parents, usually women.
The next figure compares the benefits of the head of household filing status, the CTC, and the EITC under current law, and under the Biden and Romney plans. For heads of households with one child over age six, the Romney plan means a net reduction in these benefits for almost all but those with very low incomes (under $13,625, approximately).
The same pattern can be seen in Figure 3, for households with two children, although the differences are narrowed. The Romney plan looks better in relative terms with additional eligible children, since the EITC phases out altogether and the head of household benefit does not increase with more children. With children under age six, the Romney scheme looks better still. Since it lacks the same higher-income phase-outs as the new Biden plan, Romney beats Biden incomes above roughly $140,000.
Net taxes (taxes minus credits) are shown in the next figure. A lower vertical point in the chart means a larger cash refund for points below the horizontal axis, or lower taxes otherwise. It turns out that for heads of households with one child, the Romney plan reduces credits or raises taxes for most taxpayers. Biden’s plan is better for these taxpayers for every income level below $112,500.
The disadvantages of Romney’s plan disappear for married couples filing a joint return, as shown in Figure 5. Romney and Biden identically increase credits and reduces taxes for all taxpayers, Biden more so than Romney at lower income levels, since Biden avoids Romney’s cuts in the EITC, Romney more than Biden at higher levels, since Romney lacks Biden’s higher-income phase-out for couples with incomes exceeding $150,000. With younger children, Romney would reduce taxes more than Biden for all incomes.
In a few important respects, all these comparisons are flawed. since their underlying financing differs. Biden’s plan is entirely deficit-financed, while Romney’s is “budget neutral.” It’s easier to provide a bigger benefit or tax cut without the burden of offsetting increases in revenue. On the other hand, as we discussed in my report on the Biden budget, under current circumstances, at least for 2021, a massive “free lunch” is available in the form of spending increases and tax cuts. There is no good reason to apply pay-fors in the midst of this deep recession. How either plan would fit into budget planning in the economic recovery hoped for beyond 2021 is a different matter.
As noted at the outset, other details in the respective plans not analyzed here are important. The Biden plan entails a somewhat complicated payment mechanism, since it is based on a partial advance credit paid by the IRS against future taxes. In contrast, the Romney plan locates administration in the Social Security Administration. The Biden plan is set to expire after 2021, while Romney’s runs for ten years.
The extent of new Republican interest in this sort of program makes it more possible to imagine a compromise measure that would extend child benefits beyond this year.