Taxation and the Family: What is the child tax credit?

Taxpayers can claim a child tax credit (CTC) of up to $1,000 per child under age 17. The credit is reduced by 5 percent of adjusted gross income over $110,000 for married couples ($75,000 for single parents). If the credit exceeds taxes owed, taxpayers can receive some or all of the balance as a refund, known as the additional child tax credit (ACTC) or refundable CTC. The ACTC is limited to 15 percent of earnings above a threshold that is indexed to inflation; the threshold is temporarily reduced to $3,000 in 2009 and 2010. Because the income range over which the ACTC phases in overlaps at least part of the range over which the earned income tax credit (EITC) phases out, the CTC partly offsets the high marginal tax rates associated with that phase-out.

The CTC is the largest tax code provision benefiting families with children, distributing about $45 billion to 31 million families in 2007. The credit disproportionately benefits higher-income families, because of the ACTC earnings threshold: nearly 60 percent of its benefits in 2005 went to families in the top 40 percent of the income distribution, and less than 1 percent went to those in the lowest income quintile. And although nearly every family with an eligible child in the third and fourth income quintiles (annual incomes between $27,000 and $84,000) benefits from the CTC, fewer than 10 percent of families with an eligible child in the lowest income quintile (income less than $14,000) benefits.

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• The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) doubled the CTC from $500 to $1,000 per child and made it refundable for more families. Unless Congress extends EGTRRA's provisions, the CTC will revert to $500 per child when EGTRRA sunsets in 2011, and many families will no longer qualify for the refundable credit.
• • Before EGTRRA, only families with at least three children could receive a refundable CTC up to the Social Security and payroll taxes they paid minus their Earned Income Tax Credit.
  • EGTRRA extended the refundable CTC to all families with children, setting it equal to 15 percent of earnings in over a threshold that is indexed annually for inflation. Under EGTRRA, the 2009 threshold would have been $12,550.
  • The American Recovery and Reinvestment Tax Act of 2009 temporarily reduced the threshold to $3,000 for 2009 and 2010.
  • Because EGTRRA is scheduled to expire after 2010, the new form of refundability—15 percent of earnings over a threshold—will disappear in 2011 unless Congress acts to extend it. Only the much more limited refundability for larger families would then apply.
  • The refundable CTC complicates tax filing, especially for larger families who may calculate their credit under both the EGTRRA and pre-EGTRRA rules. 
• Because the CTC is not indexed for inflation, its value erodes each year. The only credit parameter indexed to inflation is the threshold over which families can receive a refundable credit. Thus families must earn more each year to receive the same refundable credit. This affects families who do not have enough tax liability to get the entire $1,000 per child credit.
• In 2007, of children whose parents work, 27 percent lived in families who receive less than the full credit because the parents earn too little. Forty percent of these children are in families that get no credit at all because their earnings fall below the refundability threshold. Since the threshold has been lowered since then, the proportion of children in this situation has declined.
•  Possible reforms of the CTC include:
• • Make the $1,000 value permanent (even if the other EGTRRA provisions are not);
  •  Index its value and phase-out thresholds;
  • Index the maximum CTC to inflation but limit it to taxpayers who obtain health insurance for their children; or
  • Permanently lower or eliminate the refundability threshold so that all working families, especially minorities and those with low income could receive the credit.