As lawmakers prepare to expand the popular $1,000 child tax credit, they run the risk of overlooking the child care credit, a provision that cries out for expansion. The child care credit, also called the dependent care credit, offers tax relief for child care costs incurred by working single parents and by married couples in which both parents work.
The economic case for tax relief for child care costs is straightforward. If workers are taxed on their wages, they should receive tax relief for the costs they incur to earn the wages, just as businesses deduct the costs of earning the income on which they pay tax. There can be little doubt that child care costs are tied to work.
{mosads}Common sense suggests, and statistical studies confirm, that making child care cheaper encourages parents to enter the labor force. That logic persuaded Congress to provide tax relief for child care costs in 1954. Today’s child care credit offers 20 cents of tax savings, and more for some moderate income workers, for each dollar spent on child care. But the credit has two key shortcomings.
First, the tax savings apply to only the first $3,000 of child care costs for parents with one child and the first $6,000 for those with two or more children. Those limits have risen only 50 percent since 1976, failing to keep pace with rapidly rising child care costs. Congress should increase the limits and build in an automatic inflation adjustment.
Second, the child care tax credit is unavailable to workers too poor to owe individual income tax. Those workers pay Social Security and Medicare payroll taxes on their wages without any tax relief for the child care costs they incur to earn those wages. Making the credit refundable would extend relief to those workers.
In a rare moment of agreement during last year’s presidential campaign, both Donald Trump and Hillary Clinton recognized the need for additional tax relief for child care costs. Surprisingly, however, the recent tax framework set forth by the White House and the Republican congressional leadership makes no mention of expanding the child care credit.
That silence is ominous because the framework calls for the repeal of unspecified “exemptions, deductions and credits for individuals,” suggesting that the child care credit could end up on the chopping block. Some previous tax reform plans have slated the child care credit for repeal, apparently misunderstanding the need to provide tax relief for work-related costs.
One misconception views the child care credit as just another special interest tax preference that tilts the playing field in favor of a particular type of consumer spending. That objection gets things exactly backward. By taxing work, income and payroll taxes discourage spending on work-related costs. Providing tax relief for those costs is needed to level the playing field.
Another misconception sees the child care credit as unnecessary if the $1,000 child tax credit is increased. After all, increasing the child tax credit helps all parents, whether they work or stay home with their children, while the child care credit helps only working parents. But that difference is exactly why the child care credit is needed. Only working parents pay taxes on wages and need tax relief for the costs of earning wages.
Of course, parents who stay home to care for their children also incur costs as they give up the wages that they could have earned by entering the labor force. But those parents already get tax relief for their costs because they don’t earn the foregone wages, and thus don’t pay income and payroll taxes on them.
Increasing the $1,000 child credit may be a good way to provide tax cuts to the middle class. But boosting the child credit won’t provide tax relief for work-related costs and it won’t encourage work. Regardless of what Congress ends up doing with the child tax credit, it should preserve and improve the child care credit.
Alan D. Viard is a resident scholar at the American Enterprise Institute, where he studies federal tax and budget policy. He previously served as an economist at the Federal Reserve Bank of Dallas, the White House Council of Economic Advisers and the United States Joint Committee on Taxation.