The Expanding Child Tax Credit And What To Watch For

Expanding the child tax credit in the American Rescue Plan Act of 2021 marked an inflection point for social welfare programs in the tax code.

The increase in the credit’s value and eligibility changes for households with very low incomes also marked an increase in the progressivity of the tax system. Although the extension of the ARPA’s changes beyond 2021 is still pending, there will be plenty to watch for as the temporary changes are rolled out.

The ARPA’s expansion of the child tax credit resulted in a one-year, fully refundable credit of up to $3,000 per child age 6 and up and $3,600 for children under age 6, to be paid in periodic installments.

The drafters intended “periodic” to mean “monthly,” but because of the requirements of the reconciliation process, they had to settle for a more general direction to the IRS about the frequency of distributions. The income thresholds for the expansion begin at $75,000 for individual filers and $150,000 for married couples filing jointly.

The Joint Committee on Taxation estimated that the expansion would cost $105 billion between 2021 and 2022. From 2023-2026, the cost of the child tax credit would be between $710 million and $725 million per year and, after the Tax Cuts and Jobs Act provisions sunset, would drop to between $307 million and $323 million per year until 2031.

Barring any extension of the credit beyond 2021, the JCT estimates that the 10-year total cost of the credit will be $109.5 billion.

The American Families Plan fact sheet says that “the President is committed to working with Congress to achieve his ultimate goal of making permanent the Child Tax Credit as well as all of the expansions he signed into law in the American Rescue Plan.”

The proposed temporary extension until 2026, coupled with the expiring TCJA provisions, will set up a major discussion in 2025 about how the tax code affects families with children. That discussion will benefit from further information gathered in the intervening years, assuming that the temporary extension is enacted, which will be critical to the credit’s long-term prospects.

The Changing Credit

The child tax credit amount has been increasing relatively steadily since its introduction in 1997. The expansion in the TCJA followed shortly by that in the ARPA were especially big leaps.

But the elimination of any income requirement for full refundability distinguished the ARPA in the history of the credit. That temporary change could have long-term consequences for the direction of child-related tax policies.

The advertised objective of the increase in the child tax credit in the ARPA was a reduction in childhood poverty, which marked a major shift in the conception of the credit, because it had always been characterized as an adjustment to reflect the lesser taxpaying ability of households raising children.

Until now, it hadn’t played the role of primary anti-poverty measure in the tax code targeting families with children; that position was occupied by the earned income tax credit.

Under current law, for this year only unless the ARPA expansion is extended, a parent or married couple with three children may receive up to $6,728 from the EITC, but $9,000 (or up to $10,800 if all three children are under age 6) from the child tax credit. Before the ARPA, the same family would have received the same EITC amount, but $4,200 in child tax credits.

“Making the child tax credit fully refundable is a true departure from how we have treated tax benefits in the past,” said Elaine Maag of the Urban-Brookings Tax Policy Center. She said the tax system is a blunt policy tool because it doesn’t react to changes that families experience over the course of a year.

“In the next four years, we will be gathering information about whether this is a serious problem or a minor problem,” she said, adding that the information can inform the future debate.

Angela Rachidi of the American Enterprise Institute said the chief concern about the fully refundable credit is its effect on employment, especially among the lowest-income families. That concern is stronger with a permanent or semipermanent policy than it is with the one-year expansion in the ARPA.

Although the expanded child tax credit can reduce child poverty in the aggregate, if it translates into less employment for some of the most vulnerable families, those families could be worse off in the long run if the increase in the credit doesn’t make up for earnings from forgone employment, Rachidi said.

Sustained employment is important to moving up the income scale, she noted. “In the absence of a policy like this, some of those parents [who might forgo employment] would work, and that would lead to better outcomes,” she said.

Despite the bipartisan support the child tax credit has enjoyed, the political divide over the new formulation will be difficult to bridge. Republicans generally want to reinstate the previous link between the full benefit and some paid work, although making the credit more generous seems to have popular support.

Sen. Josh Hawley, R-Mo., recently proposed the parent tax credit, which would provide $6,000 for single-parent households with a qualifying child under age 13 and $12,000 for married parents and would be conditioned on prior-year earnings of at least $7,540.

The earnings threshold is set at the equivalent of 20 hours per week at the federal minimum wage. Hawley’s proposal advances the credit to families monthly. 

Sen. Marco Rubio, R-Fla., who shepherded the doubling of the credit through the TCJA, has recently reiterated his position that there should be a link between receipt of the full credit amount and some paid work.

The growing child tax credit could eclipse other aspects of the safety net for families, which might damage the mission of lifting parents and children out of poverty

Rachidi said the monthly credit could jeopardize the link between programs like Temporary Assistance for Needy Families and the families that now receive them, which could weaken the link between those households and needed social services.

“I’m afraid of what that is going to mean for families,” she said, pointing to the connections that Temporary Assistance for Needy Families provides to services like job training and assistance in situations of domestic violence and enforcement of child support.

A Look Ahead at 2025

The plan to extend the child tax credit expansion until 2026 when the TCJA provisions end means that there will be time to assess the guidelines and administration of the program.

While the first consideration for legislators voting in 2025 will likely be whether to extend the benefits, another key issue is whether to keep the program in the tax code or move it. That discussion began in the outline of the Family Security Act from Sen. Mitt Romney, R-Utah, earlier this year, in which he suggested shifting responsibility for administering the child benefit to the Social Security Administration.

One of the key data points Congress should consider regarding possible extension of the expanded child tax credit is whether the IRS can deliver it effectively. Maag said using the tax code was the only viable choice for providing a broader benefit, but that that doesn’t necessarily mean it’s the best answer for the long term.

The economic impact of the increased and fully refundable benefits will be critical to the future analysis of child-related benefits.

The four years between now and the likely reevaluation of the child tax credit in 2025 will therefore provide crucial information about the real-world effects of the recent changes.

The impact on families’ financial circumstances — whether there’s a reduction in food insecurity, more timely rent payments, increased use of higher-quality child care, and increased employment because parents can afford child care or more parents can stay home with their children — will likely be important in deciding whether to prolong the program or how to change it.

The impact of the fully refundable credit on the employment of parents with very low incomes will be an important metric.

An analysis from the American Enterprise Institute estimated that the unintended consequence of the expansion would be that employment might decrease by up to 296,000 full-time equivalent jobs because of the newly missing work incentive in the child tax credit.

The concern is that if parents with very low incomes don’t work, they will miss out on the opportunity to increase their incomes later on. Although decreased employment might be evidenced in the short-term data, the likelihood of a decrease in long-term earnings won’t be fully understood until longer-term data exists.

Eliminating the work incentives in the child tax credit isn’t the end of the story, however, because the EITC will continue to provide a substantial inducement for parents with low incomes to enter the labor market. 

Maag noted that the child tax credit, even in its expanded form under the ARPA, isn’t large enough to really enable parents to drop out of the labor force. “For young children in particular, the notion that you can only receive benefits if a parent is working does not benefit a child with immediate needs,” she added.

Another feature of the child tax credit that Congress should consider in future restructuring is periodic payments. The IRS has relatively little experience with monthly distributions, and none on the scale envisioned by the ARPA.

It will be important to gather information about how families want to receive monthly payments to understand whether the added costs make monthly distributions preferable to annual lump sum payments during the tax return filing season.

Whether the monthly payments are consistently directed to the taxpayers who are eligible for them will be another data point for legislators to consider regarding the monthly distribution scheme.

The built-in deadline for reconsidering the child tax credit in the American Families Plan might have a silver lining. 

Rachidi observed that the main tax credits targeting families with children — the child tax credit, the EITC, and the child and dependent care tax credit — have evolved in ways that weren’t intended when they were first added to the code.

The next four years might be the time to think carefully about the best ways to serve families as well as support employment, she said.