Apr 13, 2021

The child tax credit (CTC) is a part of the tax code designed to make raising children more affordable by easing the financial burden faced by families. The CTC is what is known as a tax expenditure, and it takes the form of a per-child credit for families. It works by reducing a taxpayer’s tax liability, meaning that it reduces the amount of taxes owed. It is also partially refundable, so if a taxpayer’s liability is smaller than their tax credit, that taxpayer may receive the difference up to specified maximum.

The CTC was created in 1997, and lawmakers have made changes to it over the years. In 2001, legislation increased the amount of the credit and made it partially refundable. The Tax Cuts and Jobs Act of 2017 made certain elements of the credit more generous, including doubling the maximum credit and increasing the amount of income at which the credit begins to phase out. Most recently, the American Rescue Plan made additional, but temporary, changes including increasing the age and credit for eligible children as well as eliminating the cap on the refundable portion.

In 2019, the most recent year for which data were not affected by the COVID-19 pandemic, the credit cost $118 billion — $39 billion in refundable tax credits and $79 billion in tax reductions. The Tax Policy Center estimates that 90 percent of families with children received the CTC for 2019; that translates to approximately 34 million families.

How does the CTC work?

The CTC was originally available to families with children age 16 and under, as well as (on a limited basis) families with adult dependents. Taxpayers were eligible to receive a credit equal to a percentage of their earnings, up to a maximum amount of $2,000 per qualifying child. The credit began to phase out at $200,000 for single taxpayers filing as head of households and $400,000 for married couples. Of the $2,000 maximum credit per child, up to $1,400 was refundable. The refundable portion of the tax credit is called the additional child tax credit.

The Child Tax Credit is partially refundable

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The American Rescue Plan (ARP) made a number of temporary changes (for 2021 only) that expand the child tax credit. The legislation:

  • Increased the maximum age for eligible children to those 17 and younger.
  • Eliminated the phase in based on earned income as well as the cap on the refundable portion.
  • Increased the credit amount from $2,000 to $3,600 per child age 5 and under and $3,000 per older child between ages 6 and 17.

The Earned Income and Child Tax Credits distribute benefits differently

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Under ARP, the CTC will begin to phase down at incomes above $112,500 for single taxpayers filing as head of household ($150,000 for married couples) until the credit equals $2,000 per child. The CTC starts to phase out again when income exceeds the current-law maximum of $200,000 for single taxpayers ($400,000 for married couples). A key provision of the ARP advances half of the expected credit for 2021 in periodic payments beginning on July 1, 2021. The advancement will be based on taxpayers’ 2020 income tax data, or if unavailable, 2019 income tax data. Taxpayers will claim the remaining half of the total 2021 credit when filing their 2021 tax return.

The design and effects of the CTC are often considered alongside the Earned Income Tax Credit, a credit that is designed to address poverty and has a significant impact on children. Unlike the EITC, CTC benefits accrue to those at the middle and high end of the income distribution. Three-quarters of families with the lowest incomes qualify for the credit, while 98 percent of families in the middle of the income distribution qualify. Furthermore, families with lower incomes receive lower benefits than those with higher incomes because they do not earn enough to qualify for the full credit.

The EITC and CTC are the most significant tools for the reduction of child poverty

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A study by researchers at Columbia University found that 23 million children did not generate the full tax credit under the CTC structure prior to the ARP. Of those children, 50 percent are Black non-Hispanic and Hispanic and 70 percent are the children of single parents who are female.

Effects of the CTC

While most of the CTC’s benefits flow to higher-income families, it remains a significant tool for reducing child poverty. The CTC lifted about 4.3 million people out of poverty in 2018, including about 2.3 million children, according to research by the Center on Budget and Policy Priorities.

The CTC and EITC are the largest and third-largest programs that benefit children, and taken together they reduce child poverty by nearly 20 percent. When considering the supplemental poverty measure, the Brookings Institution estimates that the expansion of the CTC under ARP will cut the rate of child poverty nearly in half — from 14.0 percent to 7.5 percent. Moreover, evidence suggests that the additional income that the CTC provides though tax credits and the refundable additional child tax credit has many of the same secondary effects as the EITC, including improving school performance and improving health outcomes.

Six popular tax provisions accounted for a large majority of annual tax expenditures for individuals

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Tax Credits and the Budget

The CTC is among the largest tax expenditures and cost $118 billion in 2019. The Joint Committee on Taxation estimates that the one-year expansion of the CTC under the ARP will cost $110 billion, mainly over the next couple of years.

Six popular tax provisions accounted for a large majority of annual tax expenditures for individuals

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What Reforms to the CTC Have Been Proposed?

Proposed reforms to the CTC generally center on making the credit available to more low-income families as well as making it more generous. Proposed reforms include permanently codifying some of the provisions in the ARP. Others include:

  • Phasing in the credit at the first dollar earned so that more low-income families can benefit, and, for certain families, increasing the phase-in rate so that families with lower incomes can receive the full benefit
  • Redesigning the CTC so that it pays out a set amount per child and clarifying certain requirements of the credit to reduce complexity

Conclusion

The CTC is a powerful and popular tool that provides assistance to families with children, and while it represents a small part of overall spending, it is one of the largest tax expenditures and a key part of our nation’s fiscal picture.

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