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Tax Subsidies to Help Low-Income Families Pay for Child Care

Leonard E. Burman, Elaine Maag, Jeff Rohaly

Published: June 23, 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).


Low-income working families face enormous challenges. Key among them is how to pay for decent child care that would allow a parent to work. This issue is especially critical for single parents who must work outside the home to survive.

The federal income tax code subsidizes child care in several ways. The largest subsidy is the Child and Dependent Care Tax Credit (CDCTC), a nonrefundable tax credit of up to 35 percent of working parents' child care costs, subject to limits. However, many low-income families cannot benefit from the credit because they have no income tax liability to offset, making the credit worthless. Even for those with tax liability, the credit rate declines rapidly with income; most families receive a smaller 20 percent credit.

Though not earmarked specifically for child care, other tax subsidies provide more help to low-income working families. The Earned Income Tax Credit (EITC) is refundable—making it valuable even to families with little or no tax liability—and increases with family size (up to two children). Similarly, the Child Tax Credit (CTC) increases with family size and is partially refundable. In 2005, families with earnings over $11,000 can receive a benefit even if they have no tax liability.

This paper considers options to reform the CDCTC to increase its value to low-income families and deal with some of its structural flaws—most notably the fact that its value declines over time because its parameters are not indexed for inflation. The paper also examines expansions to the refundable tax credits that help families with children.

The first section of the paper summarizes the tax treatment of child care under current law. The second section evaluates how child care should be taxed in an ideal tax system. The next section evaluates the effectiveness of current child care subsidies measured against those criteria, and discusses the effectiveness of recent expansions to the CDCTC. The fourth section examines options to reform the credit, while a fifth section examines expansions to the CTC and EITC as alternative options. The final section presents conclusions.


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