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A Unified Children's Tax Credit

Adam Carasso, Jeff Rohaly, C. Eugene Steuerle

Published: May 15, 2005
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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).


In a bid to simplify and rationalize the treatment of children in the tax code, we suggest a tax reform option that repeals the panoply of children-related tax provisions in the tax code and much of their attendant complexity and replaces them with a single Unified Child Credit (UCC). This effort follows on the heels of a number of proposals to consolidate and strengthen tax programs that benefit low-income families1 and reflects the spirit of the more uniform tax definition of a qualifying child that was enacted by the Working Families Tax Relief Act of 2004. This paper estimates the costs and the distributional implications of a UCC in tax year 2010 as compared to a simple, equal-cost, increase in the exemption level in the alternative minimum tax (AMT). All amounts and costs are in 2003 dollars, unless stated otherwise. We show how it is possible to reform the tax treatment of children in general while removing one of the most glaring of AMT defects: the treatment of the dependent exemption as a tax shelter.

WHY THE NEED FOR A UNIFIED CHILD CREDIT?

Families claiming tax benefits for their children face a bewildering and often conflicting array of tax programs and eligibility rules. Currently, families may apply for one or more of the following: the earned income tax credit (EITC), the child tax credit, the additional child credit, the dependent exemption,2 and the head of household rate schedule. Each program offers a different kind of benefit, such as a tax exemption, a tax credit, or a tax-advantaged rate schedule; a different benefit amount, such as a maximum of $4,200 per family versus $1,000 per child; targets a different segment of the population, such as very low income, lower to middle income, or middle to upper middle income; and phases in or phases out over different earnings and income ranges and at different rates that are often hidden and high. To save on revenues, on the other hand, lawmakers have subjected each child tax provision to different sets of phase-outs or treated one provision (the dependent exemption) as a preference item in the AMT.3 Finally, the age of child eligibility differs across programs. The complications surrounding the tax treatment of children stem from the piece-wise enactment of each new tax provision.

The unsurprising result is that some families entitled to benefits do not file for them while others that are not entitled receive benefits anyway. Very few families understand how much total benefit they might receive at a certain income and to what marginal tax rates those benefits will be subject, or what will happen to these benefits should they marry or divorce.4

The issue cannot be confined to lower income taxpayers. One can no longer address children's issues without attention to the AMT. Absent reform, by 2010, some 29.2 million tax units5—16.4 million of them tax units with children—are expected to fall on the AMT. Families with children are especially hard hit, as the dependent exemption is treated as a tax shelter by the AMT and is one of the largest provisions affecting likelihood of paying the AMT. Still, the AMT is more likely to hit upper-middle income and some higher income taxpayers than those with more moderate earnings. This has made it difficult to achieve reform, in part because some conservatives seem willing to accept the higher effective tax rates imposed by the AMT in order to keep the top statutory rates low while some liberals see AMT reform as primarily benefiting richer taxpayers.


Notes from this section

1 See Carasso, Rohaly and Steuerle (2003); Sawhill and Thomas (2001); Sawicky, Cherry and Denk (2002); Ellwood and Liebman (2000); and Steuerle (2000).

2 The dependent exemption refers to personal exemptions that are claimed for eligible children on a tax return. The proposed UCC would not affect in any way personal exemptions that adults claim for themselves.

3 A "preference item" for AMT purposes is an item in the regular income tax that is either restricted or disallowed in the AMT because it is identified as a possible tax shelter. The AMT has a different definition of taxable income than does the regular individual income tax and does not allow personal exemptions, the standard deduction, or certain itemized deductions, such as those for state and local taxes. Instead, the AMT has its own exemption that varies by filing status and its own tax brackets. See Burman et al. (2002) for details.

4 Evidence of the complexity and its adverse effect on taxpayers abounds. See, for instance, Olson (2002); Treasury (2002); Joint Committee on Taxation (2002).

5 A tax unit represents all the persons covered on a tax return. For example, a married couple with two children that files a tax return represents one tax unit while a single person with no dependents also represents one tax unit.


Note: This report is available in its entirety in the Portable Document Format (PDF).