Families Denied Child Tax Credit by Ways and Means Proposal
Are Working Families That Typically Pay Significant Amounts in Taxes
These Families Can Pay As Much As Several Thousand Dollars in Federal Taxes
by Isaac Shapiro and Robert Greenstein

The tax legislation adopted by the House Ways and Means Committee makes a very significant change in previous Republican child tax credit proposals. A Treasury Department analysis shows that the new version of the child credit denies the credit to six million children in lower-middle income families that would have received the credit under previous Republican tax proposals.⁽¹⁾ The new version of the credit also reduces the size of the credit for several million additional children in lower-middle-income families.

Most of these children 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 that these families owe no federal tax are not correct.

This change in the credit brings to 28 million the number of children who would be denied the credit because their families' incomes are not high enough. Under the Ways and Means Committee plan, the 41 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. Although the Ways and Means Committee revised the earlier Republican child credit proposals to take the credit away from six 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 New Proposal Works and Who is Affected

Under the child tax credit that Congress passed in 1995, as well as under the child credit contained in the leadership tax package introduced by Senate Majority Leader Trent Lott earlier this year (S. 2), 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 is calculated. Under the more restrictive version of the child credit that the House Ways and Means Committee has approved, however, the child tax credit could be used only to offset any income tax remaining after the EITC is applied. If the family has no income tax liability left after the EITC is applied, the family would be denied the child credit even if the family owes substantial amounts of other federal taxes, such as payroll taxes.

In recent days, Rep. Bill Archer, chairman of the House Ways and Means Committee, has sought to justify the denial of the child credit to these six million children by arguing that these children live in families that owe no federal taxes. This, however, is not the case. The large majority of the families who would either be denied the child credit under the Ways and Means Committee proposal or have the size of their credit reduced do owe federal taxes. These families receive an EITC that is smaller than the combined income and payroll taxes they pay.

In fact, many of these families have large tax bills. This can be seen by examining the overall tax burden of families in the income ranges affected by the change the Ways and Means Committee made in the child credit proposal, as well as by examining the tax bills of specific types of families that would be denied the credit.

Most families that would either be denied the child credit or have the credit reduced under the change the Ways and Means Committee has made have incomes between $15,000 and $30,000. For example, two-parent families of four with incomes between $17,500 and $27,158 will receive less under the Ways and Means child credit proposal than they would have received under the child credit proposal that Congress adopted in 1995 and Senate Majority Leader Trent Lott proposed earlier this year.⁽²⁾

Families of four with incomes between $17,500 and $24,385, who would have received a child credit under previous Republican versions of the credit, would be denied the credit altogether under the new proposal. Families of four with incomes between $24,385 and $27,158 would receive a partial child credit under the Ways and Means proposal; they would have received a full $500 per-child credit under earlier proposals.

Joint Tax Committee data issued this week show that taxpayers with incomes in these income ranges owe large amounts of federal taxes. Between 1997 and 2002, taxpayers with incomes between $10,000 and $20,000 will owe an estimated $191 billion in federal taxes. Taxpayers with incomes between $20,000 and $30,000 will owe $442 billion in federal taxes over this time span. These figures from the Joint Tax Committee reflect the taxes these families owe after Earned Income Tax Credit benefits are subtracted. (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.)⁽³⁾

Most of the families that would either be denied the child credit or have their child credit reduced as a result of the changes in the credit that the Ways and Means Committee made 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 $24,000.⁽⁴⁾

Under current law, the family's tax bill just from the income tax and the employee share of the payroll tax equals $1,700 after the EITC is subtracted.⁽⁵⁾ Under the 1995 Republican budget bill, this family would have received a child tax credit of $975, which would have reduced the family's tax bill from $1,700 to $725. But under the Ways and Means plan, the family would not receive any child tax credit to help offset its tax bill.⁽⁶⁾

Furthermore, 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 that CBO issues, treat both the employer and the employee share of the payroll tax as taxes that the employee pays. When both the employer and the employee share of payroll taxes are counted, the family's federal tax bill rises to $3,530. (See table below.)

In addition, data from the Congressional Budget Office indicate that this family's federal excise tax bill would equal approximately $370.⁽⁷⁾ When excise taxes are counted, as they should be, the family's tax bill rises to $3,900.

In short, depending upon the definition of federal taxes used, a family of four with income of $24,000 currently pays between $1,700 and $3,900 in federal taxes, after accounting for EITC benefits. Yet this family would be denied the child tax credit under the Ways and Means proposal. By contrast, under both the tax legislation Congress passed in 1995 and the Senate Republican leadership proposal introduced earlier this year, the family would have received a tax credit of $975.

As another example, consider the case of a single-parent family that has one child, earns $20,000 a year, and incurs child care expenses of $200 a month. Depending upon the definition of federal taxes used, this family currently pays between $1,300 and $3,145 in federal taxes, after accounting for EITC benefits. This family would have received a full credit of $500 under the 1995 Republican budget bill and the Senate Republican leadership tax proposal of earlier this year. The family would be denied the credit under the new proposal approved by the Ways and Means Committee.

Original "Contract" Proposal Provided More Aid to Low-Income Families
and Was Specifically Designed to Offset Employee and Employer Payroll Taxes

Not only would the Ways and Means proposal differ from the child tax credit provisions of the 1995 budget reconciliation bill and this year's Senate Republican Leadership tax bill, but the new proposal would differ even more markedly from the version of the child tax credit contained in the Contract with America. The child tax credit proposal included in the Contract 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 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. The Contract proposal also would have extended a larger child tax credit to many near-poor working families than would have been extended under the legislation Congress passed in 1995 and the current proposals. For example, a two-parent family of four with income of $20,000 would have received the full $1,000 credit under the Contract with America proposal ($500 for each child). The family would have received the full credit under the Contract to help offset its payroll taxes. This same family would have received only a partial credit of $375 under the budget reconciliation bill Congress ultimately passed in 1995. The family would receive no credit under the new Ways and Means proposal.

In early 1995, Chairman Archer and the House Ways and Means Committee altered the Contract child tax credit proposal. The Committee denied the credit to a substantial number of near-poor families that would have qualified for the child credit under the Contract because they have a net federal tax liability when their payroll taxes are taken into account. The Committee narrowed this credit to families that owe income tax, taking it away from a sizable number of near-poor working families, in order to free up funds for a cut in the corporate alternative minimum tax. Now the Ways and Means Committee would narrow the child credit further, making still more low- and moderate-income working families ineligible for it, to make room for large tax cuts in areas such as capital gains and the estate tax.

The EITC Serves Several Purposes

The proposal by the Ways and Means Committee to deny families a child tax credit if 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 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 high incomes will reap very large income gains from the Ways and Means plan.

End Notes

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 the size of the family and other tax deductions, the families affected by the Ways and Means proposal can have incomes somewhat lower than the $17,500 figure or somewhat higher than the $27,158 figure.

3. Transmission from the Joint Committee on Taxation to Senator Roth, October 24, 1995.

4. 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.

5. The family would owe income taxes of $975 and employee payroll taxes of $1,836 but would receive an EITC of $1,114. In combination — $975 plus $1,836 minus $1,114 — these factors yield a net tax payment of $1,697.

6. The family would not receive a child tax credit because the family's $1,114 EITC exceeds the family's $975 income tax liability.

7. 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 $24,000 yields excise taxes of $370.