It Takes a Tax Credit to Raise a Child


With some creative expansion, the Earned Income Tax Credit (EITC) could all but end poverty among working-class families with children and help a lot of middle-class parents as well. The EITC is now this country's second-largest means-tested program that aids the poor. (Medicaid is the largest.) It goes primarily to families that have children and survive on low income derived from employment. The credit costs more than $30 billion a year and is popular enough to encourage efforts to expand it.



Because the EITC is essentially a refund of payroll tax withholdings, families who owe little or no federal income tax can benefit. For the many low-income families in this category, credits that are not refunds (such as those for child care expenses) are not very helpful.



Consider a single mom with two children: In 1999 her standard deduction was $6,350, and she got three exemptions at $2,750 each, for a total of $14,600 in tax-free income. But that's not all. She received two child credits of $500 each, which effectively shielded another $6,667 from income tax. So this mom had to earn more than $21,267 to benefit from any credits that were not refunds.



Why should someone earning about $21,000, who doesn't owe income tax, get a refund? Such a taxpayer is liable for $3,213 in payroll taxes. The EITC defrays that burden.



But one shortcoming of the credit is the high rate at which its worth decreases as the taxpayer's earnings grow--16 percent for a family with one child and 20 percent for a family with two. A second is that EITC benefits do not increase if a family has more than two children. In February of 2000, President Bill Clinton and Vice President Al Gore proposed a modest increase in benefits for the third child.



Professor Robert Cherry of Brooklyn College and I have proposed combining the EITC, the $500-per-child tax credit, and the dependent exemption into one Unified Universal Child Credit (UUCC). For a mother with two children, this credit would rise to a maximum of $4,500. Unlike the EITC, it would not phase out immediately at higher levels of income. Instead, it would decrease gradually--at a rate of 5 percent--to a minimum of $1,300 per child.



With our approach, as family breadwinners increased their earnings, they wouldn't suffer nearly as steep a loss of EITC benefits as they now do. And if a single mother decided to marry, she would incur a much lower tax penalty than under current law. In public debate, much is made of marriage penalties; in fact, such penalties are greatest proportionally for those with the lowest incomes.



By adding benefits for each additional child, just as the tax code does now for people with higher incomes, our proposed credit would reduce marriage penalties: If a couple married, the number of children in the new family could be higher than in either of the separate families. A credit that is capped at a fixed number of children creates marriage penalties; the lower the cap, the greater the risk.



A universal credit, the UUCC would end the ghettoization of low-income families in the EITC program. The benefits of the UUCC would spread broadly from low-income persons to those of median income and higher.



The UUCC establishes a phase-in rate of 50 percent, which means that for every dollar of earnings, the credit would add 50 cents. In effect, the present minimum wage of $5.15 an hour would be raised to $7.72. But if the minimum wage were to increase, as seems likely, then a UUCC would increase as well. The credit is no substitute for a more progressive brand of welfare reform, but it does facilitate reform by increasing the rewards for working.




Visit TAP Online's Special Segment on Children and Families



Implementing Clinton and Gore's proposal would cost around $2 billion annually. Putting ours into effect would cost approximately $39 billion a year. But with the federal government running a huge budget surplus, some kind of large tax cut is inevitable. The first priority should be a tax break for working families--one that rewards work and doesn't punish marriage. The UUCC thus far is the only progressive tax cut in the hunt. It simplifies the tax code, improves work incentives, and reduces marriage penalties.



The total federal budget is in the neighborhood of $1.8 trillion annually, and a surplus of $280 billion or more is expected in the current fiscal year. Surplus projections of $4.7 trillion for over the next 10 years are likely to increase to well above $5 trillion when the Congressional Budget Office and the Office of Management and Budget issue new numbers in January 2001. So there is more than enough money to pay for a UUCC for working families.



Such a credit would provide new fiscal flexibility to states that currently have their own tax credits or are contemplating reform. With some redesign, those states could continue to piggyback on a federal UUCC and commit extra resources to children in other ways. Making quality child care more available and affordable is an obvious choice.



If partisan rancor in the U.S. Congress ever abates, we can look forward to a sizable tax cut that provides relief to the nonrich. Such a measure might even curb political appetites for additional proposals that are less well founded. In contrast, inflexible opposition to any and all tax cuts leaves the design of tax reduction to others. In light of current signs of an economic slowdown, such intransigence will not serve the nation well.



As the old saying goes, Why should the Devil have all the good tunes? Let's hope more members of Congress will find some rhythm. ยค

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