Childcare Credits versus Deduction: An Efficiency Analysis

By Yergensen, Ryan | Texas Review of Law & Politics, Spring 2018 | Go to article overview

Childcare Credits versus Deduction: An Efficiency Analysis


Yergensen, Ryan, Texas Review of Law & Politics


Introduction

A major policy issue during the 2016 presidential election was the idea of a tax break centered on childcare.1 Furthermore, in December 2017, the Tax Cuts and Jobs Act of 2017 narrowly passed after concessions were made to expand the childcare tax break to appease Republican Senators Marco Rubio and Mike Lee.2 The cost of childcare is rising steadily.3 Consequently, the political candidates of the major political parties have proposed tax breaks focused on alleviating the cost of raising children.4 Distributional benefits, economic efficiency, and market optimization, among other things, are factors often discussed as goals of the tax break. Policymakers have three options at their disposal in granting a tax break. They can institute a refundable tax credit, a nonrefundable tax credit, or a tax deduction. The fundamental difference between each political affiliations' preference of tax break depends on the goal desired. Republican President Donald Trump has advocated for a tax deduction,5 whereas Democrats Barack Obama and Hillary Clinton have preferred a refundable tax credit.6

Childcare is a cost to potential second-income earners who desire to enter the workforce. The rising cost of childcare has created a disincentive for certain individuals, namely potential secondary earners, to enter the marketplace. This disincentive can be inefficient because individuals who would otherwise enter the workplace are choosing to participate in other untaxed activities. The market misses out on those individuals who have the skills and abilities better suited for work in the marketplace but chose to engage in other activities instead. A tax break for childcare would lower the disincentive to workplace entry by lowering the cost of childcare for the parents who can best utilize their skills and abilities in the marketplace. Thus, a childcare tax break would induce more individuals to enter the workplace. Economic models show that an increase in the labor supply stemming from a lower disincentive to marketplace entry would increase the labor supply outward, which would increase productivity and boost gross domestic product.7

Before the Tax Cuts and Jobs Act of 2017, parents could claim a partially refundable tax credit for two dependent children under the age of seventeen, with a less generous additional child credit for subsequent children.8 The credit was worth $1,000 per child.9 However, the credit phased out by $50 for every $1,000 of adjusted gross income over $75,000 for single filers and $110,000 for joint filers.10 Furthermore, the taxpayer was eligible for a refundable credit if the childcare tax credit exceeded the taxpayer's tax liability.11 Nevertheless, the refundable portion of the credit was limited to 15% of earned income in excess of $3,000.12

As a candidate, Donald Trump's childcare tax break proposal was centered on a tax deduction.13 The deduction would permit parents to deduct their childcare expenses up to the average cost of childcare in their respective state of residence based on their child's age, for up to four children.14 For example, parents in the state of Texas would be able to deduct a maximum of $8,759 per child.15 The deduction would phase out for single filers when taxable income is $250,000 and when taxable income is $500,000 for joint filers.16 The tax break would have been available for all families regardless of whether both spouses worked.17

Hillary Clinton's proposal for a childcare tax break was centered on a refundable tax credit.18 However, Clinton did not expand on many of the specific details of her plan aside from stating that no American family should pay more than ten percent of its income for childcare.19 Her plan would have most likely resembled fellow Democrat Barack Obama's childcare proposal. Obama proposed a detailed plan focused on a refundable tax credit.20 Obama's second-earner tax credit would increase the child and dependent care credit that would begin to phase out as $120,000 was reported as taxable income. …

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