President Biden’s newly released budget and the Treasury Department’s “Green Book” of revenue proposals outlines a vision of more spending administered through the tax code. The proposals have revived the debate over the proper role of spending in the tax code, and relies on the Internal Revenue Service (IRS)The Internal Revenue Service (IRS) is part of the U.S. Department of the Treasury and is responsible for enforcing and administering federal tax laws, processing tax returns, performing audits, and offering assistance for American taxpayers. to further expand beyond its revenue collection mission to administer a variety of social benefits.
Over the next decade, at a cost of about $821.5 billion, many of the temporary expansions of economic relief from the American Rescue Plan Act (ARPA) would be extended or made permanent. Among trillions of dollars of other taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increases, President Biden proposes the following four changes to refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit. s:
- Premium Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (PTC): decrease the contribution percentage of household income used to determine eligibility, extend eligibility to taxpayers with household income above 400 percent of the federal poverty line, discontinue indexing the contribution percentages. Together, the changes mean more households qualify for larger credits.
- Earned Income Tax Credit (EITC)The Earned Income Tax Credit (EITC) is a refundable tax credit targeted at low-income working families. The credit offsets tax liability, the total amount of tax debt owed by an individual, corporation, or other entity to a taxing authority like the Internal Revenue Service (IRS), and can even generate a refund, with earned income credit amounts calculated on the basis of income and number of children. : increase phase-in and phaseout rates and income range for workers without children so that the maximum credit rises from $542 to $1,502. The parameters would be indexed to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . ARP age-eligibility expansions and other changes to simplify the EITC would also be permanent.
- Child and Dependent Care Tax Credit (CDCTC): refundable tax credit up to 50 percent of up to $8,000 in expenses for one child/disabled dependent ($16,000 for more than one child/disabled dependent) with a phaseout and an exclusion of up to $10,500 in employer assistance/contributions for dependent care.
- Child Tax Credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers. : extend the ARP child tax credit through 2025, including a maximum of $3,600 for children under 6 and $3,000 for children 6 through 17. Half of a taxpayer’s total allowable credit would be received as monthly advance payments and half would be paid when households file their taxes; any discrepancies would be reconciled on tax returns. Notably, by proposing that only half of the credit be paid out monthly, the resulting maximum monthly payments would be $150/$125 per child for 2022 through 2025, with the rest received at tax time, compared to maximum monthly payments of $300/$250 under the current ARP child tax credit in 2021. Full refundability, regardless of earned income, would become permanent.
Combined, the four tax credit changes would reduce federal tax revenues by about $821.5 billion from 2022 through 2031, with more than half of that attributed to the temporary extension of the expanded Child Tax Credit. In addition to the revenue effect, the Green Book provides estimates of outlay effects, isolating the portion of the tax change that constitutes an increase in spending rather than a reduction in tax liability.
For example, the American Rescue Plan expanded the Child Tax Credit for 2021, which the Joint Committee on Taxation estimated would reduce federal revenue by $105 billion in fiscal years 2021 and 2022. Approximately $84.2 billion of that $105 billion is an outlay effect, indicating most of the expansion would be received as a refund above the amount of taxes a taxpayer owes.
For the newly proposed changes to the PTC, EITC, and CDCTC, the outlay effect represents between about half to 70 percent of the total revenue effect, which indicates that the majority of the three expansions goes toward negative tax liabilities or increasing refundable tax credits. Curiously, the outlay effect of the Child Tax Credit exceeds the revenue effect. The Green Book does not explain what causes the larger outlay effect, but it could potentially be due to how monthly payments are counted in the outlay effect.
|Revenue Effect, 2022-2031||Outlay Effect, 2022-2031|
|Premium Tax Credit (PTC)||-$163B||$116B|
|Earned Income Tax Credit (EITC)||-$105B||$94B|
|Child and Dependent Care Tax Credit (CDCTC)||-$104B||$50B|
|Child Tax Credit (CTC)||-$449B||$557B|
Note: Revenue effects have a negative sign because the policies would decrease the amount of revenue raised. Outlay effects have a positive sign because the policies would increase the amount of spending through the tax code. For example, the proposed Premium Tax Credit would reduce revenue by $163 billion, of which $116 billion would be spending in the form of refundable tax credits. The two effects are not additive.
Source: Department of the Treasury, “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” May 2021, https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf.
When the underlying tax code is complex, it is difficult to implement relief measures that are simple for taxpayers to understand and for the IRS to administer. For instance, during the pandemic and economic downturn, economic relief administered through the tax code exploded as Congress passed nearly $6 trillion of legislation. That expansion in relief left the 2021 tax filing season, which ended May 17, with complications that still linger.
One area rife with complications is the advance payment and reconciliation of the expanded Child Tax Credit. Requiring the IRS to know in real time the marital status and number of dependents for millions of filers may not be a reasonable expectation of a tax agency.
The Green Book states that the “Treasury and the Internal Revenue Service will develop strategies to minimize the amount of advance Child Tax Credit payments that is paid to individuals who are ultimately not eligible for the credit.” As described by Nina Olson, executive director and founder of the Center for Taxpayer Rights, in a recent Tax Foundation webinar, the experience with economic relief during the pandemic should be used as a “proof of concept” to illustrate the resources and technologies the IRS would need to implement programs in an efficient, proactive way.
The Biden administration will have to balance the desire to increase social spending through the tax code with the need to collect revenue and have a tax system that is transparent and easy to understand.
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