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Child tax credit

Originally published in the NTA Encyclopedia of Taxation and Tax Policy, Second Edition, edited by Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle. The encyclopedia is available in paperback from the Urban Institute Press. Order online at www.uipress.org or call toll-free 1-877-847-7377

Gregg A. Esenwein
Congressional Research Service, Library of Congress

A refundable income tax credit for dependent children under the age of 17.


For tax year 2004, families with incomes below certain levels and with qualifying children were allowed a credit against their federal income tax of $1,000 for each qualifying child. To qualify for the credit, the child must be an individual for whom the taxpayer can claim a dependency exemption. The child must be under the age of 17 at the close of the calendar year in which the taxable year of the taxpayer begins.

For families with one or two qualifying children, the credit is refundable to the extent of 10 percent of a taxpayer’s earned income in excess of $10,750. (This earned income threshold is indexed annually for inflation.) For families with three or more children, the child tax credit is refundable to the extent that the taxpayer’s Social Security taxes exceed the taxpayer’s earned income tax credit or to the extent of 10 percent of their earned income in excess of $10,750, whichever is larger.

The child tax credit is phased out for taxpayers whose adjusted gross incomes (AGIs) exceed certain thresholds. For married taxpayers filing joint returns, the phaseout begins at AGI levels in excess of $110,000; for married couples filing separately, the phaseout begins at AGI levels in excess of $55,000; and for single individuals filing as either heads of households or as singles, the phaseout begins at AGI levels in excess of $75,000. These phaseout thresholds are not indexed for inflation.

The child tax credit is allowed in full against a taxpayer’s alternative minimum tax.

Legislative history

The child tax credit was enacted as part of the Taxpayer Relief Act of 1997. Congress established the child tax credit to address concerns that the tax structure did not adequately reflect a family’s reduced ability to pay taxes as family size increased. The decline (prior to its indexation) in the real value of the personal exemption over time was cited as evidence of the tax system’s failure to reflect a family’s ability to pay.

Initially, for tax year 1998, families with qualifying children were allowed a credit against their federal income tax of $400 for each qualifying child. For tax years after 1998, the credit increased to $500 per qualifying child. For families with three or more children, the child tax credit was refundable.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made several major changes to the child tax credit. The child tax credit was increased to $1,000, with the increase scheduled to phase in between 2001 and 2010. For calendar years 2001 through 2004, the credit was $600. In calendar years 2005 to 2008, the credit is scheduled to be $700; for calendar year 2009, $800; and for calendar year 2010, $1,000.

The 2001 Act also extended the refundability of the child tax credit to families with fewer than three children. For tax years 2001 through 2004, the credit was made refundable to the extent of 10 percent of a taxpayer’s earned income in excess of $10,000. Refundability was scheduled to increase to 15 percent for 2005 and later years. The refundability threshold is indexed for inflation. The 2001 Act permanently allowed the child tax credit to offset alternative minimum tax liability. All of the provisions of the 2001 Act, however, are scheduled to sunset at the end of 2010.

The Jobs Growth and Tax Relief Reconciliation Act of 2003 (JGTRRA) increased the child tax credit to $1,000 for tax years 2003 and 2004. The JGTRRA provisions expire after 2004 and, absent congressional action, the child tax credit is scheduled to revert to $700 in 2005. It will then increase to $1,000 via the phase-in schedule originally established under EGTRRA.

Analysis

Economic theory does not provide an answer to the question of how the costs of child rearing should be accounted for under an income tax. Proponents of an increased child tax credit argue that the current credit is not large enough to offset the costs of raising a child. In this view, children should be considered an investment in the future, and as such, the costs associated with child rearing should be deducted, as are other investment costs. Critics argue, however, that the federal income tax was never intended to provide offsets for the full financial responsibility of raising children. Indeed, some argue that the decision to have children represents a choice of how to consume one’s income, and therefore the costs of raising children should not be a consideration when assessing income taxes.

Historically, the federal income tax has differentiated among families of different size through the combined use of personal exemptions, dependent care credits, standard deductions, and the earned income tax credit. These provisions were modified over time so that families of differing size would not be subject to federal income tax if their incomes fell below the federal poverty level.

The child tax credit represents a departure from past policy practices because it is not designed primarily as a means of differentiating between families of different size at or near the poverty threshold, but rather is designed to provide general tax reductions to middle- and upper-income taxpayers with dependent children under the age of 17. Poverty-level families with incomes below the refundability threshold receive no tax benefits from the child tax credit.

Empirical evidence from the Congressional Budget Office suggests that for families with children (except those families in the highest income quintile), the overall federal tax burden fell between 1979 and 2000. The 2001 and 2003 Acts (with their reductions in marginal income tax rates, reductions in taxes on capital gains/dividend income, and marriage penalty tax relief), continued the trend of reducing federal taxes on families, especially high-income families filing joint returns.