Child Tax Credit
Adopted by Senate Finance Committee
Takes Credit Away from Four Million Children in Near-Poor and Lower-Middle-Income Working Families
Pay Substantial Amounts in Taxes
by Isaac Shapiro and Robert Greenstein
The tax legislation the Senate Finance Committee approved last week makes a major change in previous Republican child tax credit proposals. The Finance Committee legislation denies the child credit to approximately four million children in lower-middle-income families that would have received the credit under both the reconciliation bill Congress passed in 1995 and the Republican Leadership tax bill that Senate Majority Leader Trent Lott introduced earlier this year. In addition to taking the credit away from these four million children, the Finance Committee plan reduces the size of the child credit for several million others.
Most of the children who would be denied the credit or have their credit reduced live in families that owe federal taxes. Their tax burdens often amount to several thousand dollars even after the effects of the Earned Income Tax Credit are accounted for. Claims these families owe no federal tax are not correct.
This change in the credit brings to 26 million the number of children who would be denied the credit because their families' incomes are not high enough. Under the Finance Committee plan, the 38 percent of U.S. children with the lowest incomes would receive no child tax credit.
Several million additional children from lower-middle-income families would receive a partial credit that is, a credit of less than $500. Some of the families that would get a partial credit would have received a full credit under earlier Republican tax plans.
By contrast, only three percent of children live in well-to-do families with incomes so high that they would not be eligible for the credit. While the Finance Committee revised the earlier Republican child credit proposals to take the credit away from four million more children in near-poor and lower-middle-income families, it made no changes to scale back the availability of the credit to children in more affluent families. Under the Committee plan, married families with incomes up to $110,000 would qualify for a full credit, while families with incomes up to $150,000 would receive a partial credit.
How the Child
Credit For Lower-Middle-Income Families Has Shrunk
Family Income Level
|Child Credit Under Contract With America||Credit Under 1995 Reconciliation Bill and 1997 Senate Leadership Bill||Credit Under Finance Committee Proposal|
|$17,500||$ 195||$ 0||$ 0|
How the Finance Committee Changed the Earlier Republican Child Credit Proposals
Under the child tax credit that Congress passed in 1995, as well as under the leadership tax package Senator Lott introduced in January (S. 2), a family would receive a credit of up to $500 per child if the family owed income tax before the Earned Income Tax Credit was computed. Under the version of the child credit the House Ways and Means Committee approved June 12, however, a family would receive the child credit only if it had an income tax liability remaining after the EITC was applied. If the family had no income tax liability left after the EITC was applied, the family would be denied the child credit, even if the family owed substantial amounts of other federal taxes such as payroll taxes. The Treasury Department estimates that the Ways and Means legislation would deny the child credit to six million children who would have received it under earlier Republican tax plans.(1)
Last week, Senator William Roth, chairman of the Senate Finance Committee, unveiled a chairman's "mark" that contained the same proposal in this area as the Ways and Means Committee plan. During Finance Committee consideration of the tax legislation, the proposal was changed modestly. Under the tax package the Finance Committee approved, a family will qualify for the child credit if it has an income tax liability remaining after half of the family's EITC is applied. Approximately four million children who would have received the child credit under the earlier Republican tax proposals will lose the credit under the Finance Committee proposal.
Treasury Department estimates indicate that the Finance Committee plan restores about one-quarter of the child tax credit benefits the Ways and Means Committee plan would take away from these modest-income families. Thus, the Finance Committee essentially ratified the substantial majority of the Ways and Means Committee's reductions in this area.
What both the Ways and Means Committee and the Finance Committee plans overlook is that nearly all of the families that would be denied some or all of the child credit as a result of the actions the committees have taken are families that work and pay taxes. These families receive an EITC that is smaller than the combined income and payroll taxes they pay. As a result, these families owe taxes.
The Taxes These Families Pay
Proponents of these restrictions in the child tax credit justify the denial of the child credit to these four million children by arguing that the children's parents pay no federal taxes. This, however, is not the case.
Most families that would have received the credit under earlier Republican proposals but be denied the child credit or have their credit reduced under the Finance Committee plan have incomes between $15,000 and $30,000. For example, two-parent families of four with incomes between $17,500 and $26,280 would receive less under the Finance Committee's child credit proposal than they would have received under the child credit Congress adopted in 1995 and Senator Lott proposed earlier this year.(2) Families of four with incomes between $17,500 and $22,360 would be denied the credit altogether, while families of four with incomes between $22,360 and $26,280 would receive a partial child credit but would have received a full $500 per-child credit under earlier Republican tax plans.
Joint Tax Committee data issued this month show that families in these income ranges pay substantial amounts of federal tax. Between 1997 and 2002, taxpayers with incomes between $10,000 and $20,000 will pay an estimated $191 billion in federal taxes. Taxpayers with incomes between $20,000 and $30,000 will pay $442 billion in federal taxes over this time span. These figures from the Joint Tax Committee reflect the taxes these families will pay after Earned Income Tax Credit benefits are subtracted.(3) (The vast majority of the taxes these families pay consist of taxes other than income taxes. These taxes consist primarily of payroll taxes but also include excise taxes and some other, small taxes.(4))
|How the Proposed Change Would Affect a Family of Four Earning $22,000|
|Income Tax||Employee Share of Payroll Tax||EITC||Child Tax Credit|
|Republican Budget Reconciliation Bill (1995) and S. 2 (1997)||$22,000||$675||$1,683||-$1,535||-$675|
|New version of child credit adopted by Finance Committee||$22,000||$675||$1,683||-$1,535||$0|
Most families that would be denied the child credit or have their child credit reduced are families that owe federal taxes after the benefits of the EITC are taken into account. Consider, for example, a two-parent family of four that has income of $22,000.(5)
Under current law, the family's tax bill from the income tax and the employee share of the payroll tax equals $820 after its EITC is subtracted.(6) Under the 1995 Republican budget bill, this family would have received a child tax credit of $675. Under the Finance Committee plan, the family would not receive any child tax credit to help offset its tax bill.(7) (See box at top of page.)
Families In the $17,000-$26,000 Range Now Pay in Federal
Family Income Level
|Income Tax (Net of the EITC) Plus Employee Share of Payroll Tax||Income Tax (Net of the EITC) Plus Employee and Employer Share of Payroll Tax||Child Credit Under Finance Plan|
|$17,500||$ -1,144||$ 195||$ 0|
Most economists and the Congressional Budget Office believe that the payroll taxes which employers pay on behalf of their employees are effectively paid by the employees themselves because these taxes reduce the wages the employees otherwise would receive. Accordingly, most economic analyses, including those CBO issues, treat both the employee and the employer share of the payroll tax as taxes the employee pays. When both the employer and the employee share of payroll taxes are counted, the federal tax bill of this family of four with $22,000 in earnings rises to $2,500. (See table at top of page.)
In addition, data from the Congressional Budget Office data indicate that this family's federal excise tax bill would equal approximately $340.(8) When excise taxes are counted, the family's tax bill rises to $2,850.
In short, depending upon the definition of federal taxes used, a family of four with income of $22,000 currently pays between $820 and $2,850 in federal taxes, after accounting for EITC benefits. But such a family would be denied the child tax credit under the Finance Committee proposal.
As another example, consider a single-parent family that has one child, earns $18,500 a year, and incurs child care expenses of $200 a month. Depending upon the definition of federal taxes used, this family pays between $730 and $2,430 in federal taxes, after accounting for EITC benefits. The family would have received a full credit of $500 under the 1995 Republican budget bill and Senator Lott's proposal. The family would be denied the credit under the Finance Committee plan.
Original "Contract" Proposal Provided More Aid to Low-Income Families
Not only would the Finance Committee proposal differ from the child tax credit provisions of the 1995 budget reconciliation bill and this year's Republican Leadership tax bill, but it would differ even more sharply from the child tax credit in the Contract with America. The Contract's child tax credit proposal would have allowed the $500-per-child credit to be applied against a family's net tax burden from the combination of the income tax, the EITC, and the payroll tax. The Contract included both the employer and employee share of the payroll tax in determining a family's child credit.
The Contract would have allowed many families that owe no income tax after the EITC is considered, but that pay hefty payroll taxes, to receive the child credit. The Contract proposal also would have provided a larger child tax credit to many near-poor working families than these families would have received under subsequent child credit proposals. Under the Contract, a two-parent family of four with income of $20,000 would have received the full $1,000 credit ($500 for each child) to help the family offset its payroll taxes. Such a family would have received a partial credit of $375 under the budget reconciliation bill Congress passed in 1995. The family would receive no credit under the current Finance Committee and Ways and Means Committee proposals.
Thresholds for Child Credit
Contract with America
1995 Reconciliation Bill and 1997 Senate Leadership Bill
|Senate Finance Committee|
|Income Level at Which Family Begins to Get Child Credit||$16,965||$17,500||$22,360|
|Income Level at Which Family Gets Full Child Credit||19,068||24,165||26,280|
In early 1995, Congress altered the child tax credit proposal in the Contract. In writing the 1995 reconciliation bill, Congress denied the credit to a substantial number of working poor families that would have qualified for it under the Contract; Congress limited the child credit to families that owe income tax before the EITC is applied, thereby taking the credit away from a substantial number of families with incomes close to the poverty line that owe no income tax but pay large amounts of payroll tax. The Ways and Means Committee narrowed the child credit in this manner in 1995 to free up funds for a cut in the corporate alternative minimum tax; the Finance Committee then adopted the House's more restrictive child credit approach. Now, the Senate Finance Committee and House Ways and Means Committees have narrowed the child credit further, making still more low- and moderate-income working families ineligible for it.
The EITC Serves Several Purposes
The proposal by the Finance Committee to deny families a child tax credit if half of the value of their Earned Income Tax Credit exceeds their federal income tax liability reflects a misunderstanding of the objectives of the EITC.
Since its inception in 1975, a primary objective of the EITC has been to offset payroll taxes. This goal has traditionally received support from Republicans and Democrats alike.
The EITC also has had the objective of offsetting increases in excise taxes. EITC expansions enacted in both 1990 and 1993 were designed, in part, to offset the regressive impact on low- and moderate-income working families with children of increases in excise taxes such as the tax on gasoline.
The expansion of the EITC in recent years also has reflected concern over the erosion in the living standards of families with low- and moderate-earnings. In particular, these EITC expansions were viewed by many members of both parties as a mechanism to help offset the decline in the value of the minimum wage (and by some members, particularly on the Republican side of the aisle, as an alternative to keeping the minimum wage up with inflation). Even when the minimum wage is raised to $5.15 an hour next year, its value will be 17 percent below its average value in the 1970s, after adjusting for inflation.
Even with these expansions in the EITC, families with incomes between $15,000 and $30,000 have not experienced significant income gains since the 1970s. By some measures, including a respected measure of after-tax income developed by the Congressional Budget Office, families in these income ranges have experienced income losses, after adjusting for inflation. To deny these families the child credit, or to diminish the size of the credit they receive, is of dubious merit when many families with very high incomes will reap handsome income gains from the Finance Committee plan.
1. An earlier Center analysis estimated that the House Ways and Means Committee proposal would deny the child credit to four million children, compared to earlier Republican tax plans. This estimate was not based on use of a tax estimation model like those the Treasury Department, the Joint Committee on Taxation, and the Institute for Tax and Economic Policy use. As a result, the Center's estimate could not be calculated with the precision those models provide, and the Center made sure to err on the conservative side. Since the Center issued its estimate, the Treasury Department has analyzed this matter and has determined that the Ways and Means Committee's decision to change the relationship between the child credit and the EITC would make six million children ineligible for the child credit. The Treasury estimate is firmer than the Center's earlier estimate. The Center is now using these Treasury figures.
2. Depending on factors such as family size and other tax deductions, the families affected by the Finance Committee proposal can have incomes somewhat lower than $17,500 or somewhat higher than $26,280.
3. These figures do not include payroll taxes paid by employers on behalf of workers.
4. Transmission from the Joint Committee on Taxation to Senator Roth, October 24, 1995.
5. The families in this example take the standard deduction and do not claim the Dependent Care Tax Credit. The families depicted in these examples thus are typical of families in this income range.
6. The family would owe income taxes of $675 and employee payroll taxes of $1,683 but would receive an EITC of $1,535. In combination $675 plus $1,683 minus $1,535 these factors yield a net tax payment of $823.
7. The family would not receive a child tax credit because half of the family's $1,535 EITC or $717 exceeds the family's income tax liability of $675.
8. CBO estimates that in 1998, families with incomes between $20,000 and $30,000 will pay, on average, 1.54 percent of their income in excise taxes. Applying this average to a family with income of $22,000 yields excise taxes of $340.