September 4, 1996

ADDITIONAL INFORMATION ON THE PROPOSED
CHILD TAX CREDIT

How the Proposal Differs from Earlier Proposals

Under the child tax credit that Congress passed in 1995, a family would receive a credit of up to $500 per child to be applied against the family's income tax liability. The child credit would be applied before the family's eligibility for the earned income tax credit was calculated.

Consider, for example, a married family of four that earns $23,650 a year (and neither itemizes deductions nor reduces its income tax by claiming the Dependent Care Tax Credit, which can be taken by families with out-of-pocket child care costs). This family currently owes $1,005 in income tax. Under the child tax credit that Congress approved in 1995, this family would receive a $1,000 child tax credit — $500 for each of its two children.

Under the Dole plan, however, the family's EITC benefit would first be subtracted from its income tax. This family qualifies for an EITC of $1,023. Subtracting its $1,023 EITC from its $1,005 income tax liability leaves no net income tax liability remaining. ¹ The family would consequently be ineligible for the child tax credit under the Dole plan.

Yet this family would still owe a substantial amount in federal taxes. This family owes $1,809 in the employee share of the payroll tax. Its overall income and payroll tax burden — when the income tax, the EITC, and the payroll tax are all included — is $1,791. Despite the fact that the family pays this much in federal taxes, however, it would not qualify for the child tax credit because under the Dole plan, the child tax credit can be used only to offset income tax that remains after the EITC is applied — and can not be used to offset any part of the payroll tax. More than 70 percent of Americans now pay more in payroll tax than income tax.

By contrast, the original version of the child tax credit, contained in the Contract with America, would have allowed the $500-per-child credit to be applied against a family's net tax burden from the income tax, the EITC, and the payroll tax. The Contract proposal would have allowed many families that owe no income tax after the EITC is considered but pay hefty payroll taxes to receive the child credit. This aspect of the Contract proposal was removed in the spring of 1995 by the House Ways and Means Committee to free up funds for the addition of a cut in the corporate alternative minimum tax.

Under the child tax credit that Congress passed in 1995, some 24 million low- and moderate-income children would have been denied the credit. Under the Dole proposal, the number of children ineligible for the credit due to low family incomes would rise to 28 million. No comparable data are available for the original Contract version, but the number of children ineligible under that version would be lower than 24 million.


At What Income Level Can Families Receive the Dole Child Credit?

Under the Dole budget plan, families do not receive the child credit until their income tax liability is greater than any earned income credit for which they qualify. The exact income level at which a family's income tax liability will exceed the amount of its earned income credit depends upon several factors:

• How many members there are in the family. A family with more children receives additional personal exemptions. In addition, a family with two or more children receives a larger EITC than a family with one child. As a result, larger families begin to have a net income tax liability at a higher level of income than smaller families do. Since a family would not qualify for the child tax credit unless it owed income tax, larger families would have to reach a higher level of income before they could receive the child tax credit than small families would.
  
  
• Whether the family itemizes deductions or takes the Dependent Care Tax Credit to help defray a portion of child care costs it incurs. If the family itemizes (because, for example, of high medical expenses) or takes the Dependent Care Tax Credit, it will not begin to owe income tax until its income reaches a higher level than the level at which families begin owing income tax if they neither itemize nor claim the Dependent Care Tax Credit.
  
  

Two other factors would affect the income level at which a family begins to qualify for the child tax credit under the Dole plan — the amount of the family's income tax and the amount of its EITC. If the EITC is cut, as the Congressional budget resolution proposes, the family will begin to qualify for the child credit at a somewhat lower level of income. (This is because if the EITC is smaller, a family will begin to incur a net income tax liability at a lower level of income.) On the other hand, if income tax rates are cut as Mr. Dole proposes, the family will begin to incur a net income tax liability — and hence will qualify for the child tax credit — at a somewhat higher level of income.

The following table shows the income levels at which different types of families would first begin to qualify for the child tax credit that Mr. Dole has proposed. This table does not assume changes in the EITC or income tax rates (see next section). All families in the table are assumed to take the standard deduction rather than to itemize.

Families That Would Face Tax Increases Under the Overall Dole Budget Plan

The Dole plan includes the reductions reflected in the latest Congressional budget resolution. The resolution assumes $18.5 billion in EITC cuts through 2002. In addition, the Dole plan assumes a 15 percent across-the-board reduction in income tax rates.

To assess the combined effect of these changes, we calculated the income and payroll tax burdens, the EITC, and the child credit for families at different income levels under both current law and the Dole plan. For the Dole plan, the full 15 percent reduction in income tax rates is assumed to be in effect. To estimate the effects of the $18.5 billion in EITC reductions, we took the EITC reductions affecting families with children through 2002 in last year's budget reconciliation bill and reduced them proportionately so that these cuts, in conjunction with the elimination of the small EITC for very poor workers without children, would equal $18.5 billion over this period. ²

The following table shows the results for various types of families that would suffer a net loss because their EITC cut would exceed the benefit, if any, they would derive from the child credit and the income tax rate cut. Most of these families would face a tax increase (i.e., the net amount they would owe the federal government in income and payroll taxes would rise).

These examples do not include any families that receive Social Security, which some working families get because one parent is permanently disabled. Under last year's budget bill, large additional EITC cuts would be imposed on low- and moderate-income working families that receive Social Security. The effect of that particular EITC reduction is not reflected in these tables; families affected by such a reduction would face larger losses than those shown here.

The next table provides additional information. It shows the income ranges in which families would be net losers as a result of the tax changes in the Dole plan. For example, under the Dole plan, a two-parent family of four with no child care costs would be worse off than under current law if it had income between $17,040 and $23,690.

How Many Children in High-income Families Would Be Ineligible for the Child Credit?

A precise estimate is not available of the number of affluent children who would not qualify for the child credit because their family's income is too high. In 1995, a group of House members developed a child tax credit proposal under which the child credit both for single-parent filers and for married couples filing jointly would begin to phase down when income surpassed $95,000. This version of the child tax credit proposal would have disqualified 3.1 million children from high-income families, about four percent of U.S. children.

The Dole plan differs from this earlier proposal in two ways. First, it sets the income level at which the child credit begins to phase down at $75,000 for single-parent filers and $110,000 for joint filers. Since most high-income children live in married-couple families — and the $110,000 threshold for such filers is higher than the $95,000 threshold under the earlier plan just described — this difference would reduce the number of affluent children disqualified under the Dole plan. On the other hand, the new Dole plan also would restrict eligibility for children whose families pay the alternative minimum tax. That would slightly increase the number of affluent children made ineligible under the Dole plan.

As a result of these changes affecting high-income families, the Dole proposal makes approximately five percent of children ineligible for the credit because of their family's affluence. Since the $75,000 and $110,000 thresholds are not indexed, this proportion would rise modestly over time. By contrast, the Dole plan makes 40 percent of children ineligible for the credit because their income is too low.

Footnotes

1. The EITC is a refundable credit, which means that if a family's EITC exceeds the income tax it otherwise would owe, the IRS sends the family a check for the difference. In this case, the family's EITC of $1,023 exceeds its income tax liability of $1,005 by $18. The family consequently would owe no income tax since its EITC would cancel out the income tax it otherwise would owe. The IRS would send the family a check for the remaining $18 in its earned income credit.

2. Although Congress could achieve the EITC savings in a different manner than it followed in the 1995 reconciliation bill, Congress could not avoid making large numbers of working families with children worse off. The budget resolution calls for $18.5 billion in EITC savings. Since eliminating the EITC for very poor workers without children saves only about $4 billion, and the measures Congress approved last year to reduce EITC errors have already become law as part of the welfare bill, the EITC for working poor families with children would have to be cut more than $14 billion to achieve the $18.5 billion in savings.

Furthermore, the EITC cuts that Congress passed last year were designed so they would not affect the poorest working families. Under last year's proposed EITC cuts, most working families with children that have incomes below the poverty line would not be affected. The number of lower-middle-income working families made worse off under the Dole plan could be reduced somewhat by shifting some of the EITC cuts to poorer families. But that would simply make millions of other working families — primarily the working poor — worse off. And in so doing, it would push millions of working poor families deeper into poverty.

3. This family has a negative tax liability. Under current law, its EITC exceeds its combined income and payroll tax by $239.