Over the course of the 2020 presidential election campaign, Democratic nominee Joe Biden has proposed new tax credits for health insurance, child care, elderly care, and homeownership, in addition to expansions of the 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. and Earned Income 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. (EITC). These proposals increase spending through the 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. code and amplify the redundancy, complexity, and error rates within the tax code, overlooking alternatives that would improve the tax code and help individuals increase their incomes.
These credit proposals have a major impact on federal revenue collection within Biden’s overall tax plan. The Tax Foundation estimates that Biden’s CTC expansion plan (temporarily applying only in 2021) would cost $105 billion in 2021, while the childcare and dependent credit (CDCTC) plan would cost $80.7 billion over 10 years. The first-time homebuyer credit would cost $164.6 billion over 10 years. The remaining miscellaneous credits account for about $134 billion in lost revenue over the budget window. Together, the credits reduce the revenue raised under Biden’s plan by more than $480 billion. If the CTC proposal were made permanent, it alone would offset up to 40 percent of the revenue raised from Biden’s proposed tax hikes.
These proposals come after a previous expansion of the CTC in 2017 as part of the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. , which doubled the total credit amount and increased the amount lower-income filers can receive as a refund if their credit value exceeds their liability. Filers in the lowest quintile saw increased negative effective tax rates for both 2018 and 2019, in part due to the expanded CTC. However, the TCJA did not address much needed simplifications to existing tax credits.
Further expanding existing tax credits likewise does not address the recurring problem with incorrect credit payments. The Treasury Department recently found that 25 percent of all EITC payments continue to be sent out incorrectly. As I have written on several occasions, increasing credits on a temporary basis is a misguided idea which leads to more confusion, fraud, and misallocation (e.g., overpayments or payments in error).
For example, trying to expand the CDCTC to be fully refundable adds complexity to the code and more compliance hurdles by requiring taxpayers to determine eligibility for dependents under EITC, CTC, and CDCTC to obtain economic relief. Increased compliance costs means that taxpayers will be less likely to claim eligible relief.
Moreover, some might argue that sending more money via means-tested credits, as opposed to spending, is the more targeted method of relief for lower-income families. But consider, for example, that the CDCTC primarily benefits upper-income filers who can afford childcare, not those struggling to live paycheck to paycheck.
As a technical matter, credits are treated as “revenues not collected,” similar to other tax expenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans. s like the mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act reduced the amount of principal and limited the types of loans that qualify for the deduction. or charitable deduction. These credits would create more holes in the code and provide a potential avenue for stealth spending; i.e., spending outside the normal appropriations process.
While reforming these credits may make sense for the long term, there are far better ways to provide individuals and families with tax relief liquidity during the ongoing crisis than changing tax credits that would not be available until tax filing season
Over the long term, removing the tax code’s barriers to work and to investment in addition to addressing complexities within current tax credits would also help taxpayers.
Some ideas for reforming the code along these lines include:
- Eliminating marriage penalties in credits and individual income tax rates
- Reducing barriers to capital creation through full and immediate expensing
- Simplifying and consolidating the current credits to make the system work more efficiently, reducing fraud rates which misuse taxpayer dollars, and ensuring taxpayers receive benefits as policymakers intend.
Instead of adding more pages to the tax code, policymakers should design an improved tax code which reduces compliance burdens, encourages investment and job creation, and removes distortions to work, marriage, and having children.Share