The Wyden-Smith proposed tax legislation would make four changes to the Child Tax Credit (CTC). First, it would increase the cap on the refundable portion of the CTC, eventually to the same amount as the maximum non-refundable CTC. Second, it would begin indexing the maximum non-refundable CTC with inflation. Third, it would apply a one-year lookback for qualifying for the refundable portion of the CTC, allowing parents to use either the current or previous year earnings, whichever yields a higher benefit. Fourth, it would apply the refundable portion of the CTC on a per-child basis, so that the current 15 percent phase-in rate would instead be 30 percent for a family with two children and 45 percent for a family with three children. (In general, the phase-in rate would be 15 percent times the number of dependent children.)
In a recent paper, we (with our coauthors Angela Rachidi and Matt Weidinger) provided the first—and to our knowledge only—analysis modelling how the one-year lookback affects work incentives and employment, modelling both the reduced incentives for consistently working parents to continue working every year and the increased incentives for never-working parents to start occasionally working. We estimated an annual net reduction of about 150,000 workers due to the one-year lookback.
This post provides a look at the fourth provision of the Wyden-Smith legislation, the application of a per-child benefit. Recent analysis of this provision has focused on its benefits for families, but has done so without considering the full picture of tax and transfer programs already in place.
Figure 1 below shows, for a single parent with three children, the family’s total income after adjusting for taxes and transfers for any given level of earnings. It accounts for federal income tax, the employee portion of the federal payroll tax, the Supplemental Nutrition Assistance Program (SNAP), the Earned Income Tax Credit (EITC), and the CTC. It breaks the CTC up into the existing amount (assuming a $1,800 cap on the refundable portion is applied in tax year 2023, as set forth by the Wyden-Smith bill), and the additional amount if the refundable portion was provided on a per-child basis. Since the parent has three dependent children, the refundable credit would phase in at a 45 percent rate in this case. Note that the sudden cliff around $33,500 of earnings is a result of lost SNAP eligibility.
Figure shows post-tax, post-transfer income given any level of tax unit earnings, for a single parent with three dependent children. Figure accounts for federal income tax and the employee portion of the federal payroll tax. For existing law, we apply 2023 tax law without the proposed Wyden-Smith CTC changes, except that we apply the proposed $1,800 maximum refundable CTC. The per-child refundable CTC is 45 percent of earned income above $2,500 before phasing out as the non-refundable CTC phases in. We apply SNAP benefit parameters that took effect starting October 1, 2023, and we assume shelter costs of $1,500 per month and no other deductions.
One striking aspect of Figure 1 is that a single parent with three children who earns between $15,000 and $20,000 per year would have a total income of $37,200 to $41,300, of which around $3,000 (or more) is a result of the CTC expansion. These benefits more than double the family’s earnings in this range. This does not account for other potential benefits received, such as Medicaid, housing assistance, Temporary Assistance for Needy Families, Supplemental Security Income, child care subsidies, and other nutrition programs.
A second striking aspect of Figure 1 is a large incentive for low-wage and/or part-time work. For example, a single parent who joins the workforce and earns $15,000 per year will see her post-tax, post-transfer income rise by $25,600. Thus, she receives an average effective wage subsidy of 70 cents per dollar of earnings. Without the additional $3,500 of CTC benefits due to adopting the per-child benefit provision, the effective wage subsidy would be 47 cents per dollar of earnings.
A third striking aspect of Figure 1 is a large disincentive for substantially increasing earnings. For example, consider a parent currently working 20 hours per week for $20 per hour (within a few dollars of the minimum wage in an increasing number of areas). Her annual earnings would total $20,000. By moving into full-time work at the same $20 hourly wage, her earnings would rise to $40,000. Under the proposed law, her total income would rise by only $3,400 as a result of earning $20,000 more, an effective tax rate of 83 percent. Under existing law, her total income would rise by $6,200, for an effective tax rate of 69 percent. A 14 percentage point increase in the effective tax on moving from part-time to full-time work for some parents could ultimately stunt upward mobility. The effective tax on increasing earnings could even exceed 100% for other earnings changes, or when accounting for other means-tested benefits such as housing assistance.
In a future post we will provide a look at marriage incentives when applying the per-child benefit in the Wyden-Smith bill.