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Families Can Use the Child Care Tax Credit to Pay for Informal Day Care, But the System Can Be Improved
The COVID-19 pandemic is changing the face of child care. Formal, licensed child care centers have struggled to stay afloat in the face of rising costs and declining enrollment. Instead, parents increasingly have turned to less formal home-based care, which often has fewer children gathered together. Some families can use the child and dependent care tax credit (CDCTC) to help subsidize home-based care, but its benefits are ill-timed and not available to the lowest-income households.
During the campaign, President-elect Biden proposed several important improvements to the existing CDCTC, but to make the tax subsidy most effective for low- and moderate-income families, he should also fix the timing mismatch.
Home-based providers typically care for fewer children than center-based child care. They often are families, friends, and neighbors who are subject to fewer licensing requirements. Many states have reduced or eliminated subsidies for this type of care, which can make access to child care more difficult for low-income families.
The federal CDCTC can offset some out-of-pocket costs of these informal care programs. But because the credit is nonrefundable, meaning it can only offset income taxes owed, few benefits go to the lowest-income families. Biden’s campaign proposal would address this situation in three ways. It would:
- Cover up to 50 percent of the first $8,000 of child care expenses ($16,000 for families with more than one child)—much more generous than the current 35-percent maximum credit for the first $3,000 ($6,000 for families with more than one child);
- Extend eligibility for the maximum credit (instead of the reduced 20-percent credit rate) to those with annual incomes of $125,000, up from $15,000 today; and
- Make the tax credit fully refundable.
Together, the first two steps would provide larger benefits to many middle- and higher-income families with child care expenses because the higher allowable expenses and the increased tax credit rates would apply to most of these families. And making the credit fully refundable would assist the lowest-income families who pay for child care. A similar proposal was contained in the House-passed Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, which we analyzed here.
However, because parents still would not receive the expanded CDCTC until they file their tax returns, the credit may be less useful to low-income families. The problem: Cash-strapped parents generally must pay for child care as it is delivered. They can’t wait for a tax refund to offset part of the cost. Ideally, families could receive the credit throughout the year as child care expenses were incurred.
Once the pandemic ends, more parents will be returning to work and the need for child care—both small in-home care and more formal day care—will grow. As that happens, it will be important for the federal government to provide adequate, flexible financial support to offset child care costs.
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