Last week, Joe Biden put out his proposal for the next round of coronavirus relief. The proposal includes the following bit of text on the Child Tax Credit (CTC) :
The lowest income families are particularly vulnerable in the midst of the pandemic, and President-elect Biden is calling for one year expansions of key supports for families on an emergency basis. The Child Tax Credit should be made fully refundable for the year. Currently, 27 million children live in families with household incomes low enough that they didn’t qualify for the full value of the Child Tax Credit, and this measure would give these children and their families additional needed resources. The president-elect is also calling to increase the credit to $3,000 per child ($3,600 for a child under age 6) and make 17 year-olds qualifying children for the year.
This text does not say that this one-off CTC will be paid out monthly and the Huffington Post has reported that it will not be paid out monthly but rather at tax time in 2022. Despite this, several media figures seem to believe that it will be paid out monthly, apparently because the legislation it is based on — the American Family Act (AFA) — has an advanced monthly refund in it.
It is hard for me to believe that the advanced monthly refund spelled out by the AFA could be set up before 2022. Indeed, the legislation actually gives the IRS one year to set it up, presumably because the drafters also believe it would be impractical to set it up so quickly.
The reason it would be hard to set up quickly is because the advanced monthly refund mechanism is a comically complicated and bad policy design that would require an enormous amount of new administration to pull off. And even if you did pull it off, the proposal would generate horrible user experiences.
Two Tax Returns Per Year
The way a typical refundable tax credit works is that, when you are filing your taxes at the end of the year, you figure out what your federal income tax liability is, then you subtract from that number the amount of the refundable tax credit. If the resulting figure is negative, then the government sends you a check equal to the negative amount.
So, for example, if you have $2,000 of federal tax liability, but you are also eligible for $3,000 of refundable tax credits, then you would receive a $1,000 check because $2,000 minus $3,000 equals -$1,000.
The advanced monthly refund proposal is meant to work similarly except that, rather than waiting until you file your taxes at the end of the year, you get the benefit in advance every month. So someone in the tax situation described above would receive $1,000 / 12 = $83.33 per month.
At the highest level of abstraction, this sounds cool. And reporters who stay at this highest level of abstraction inevitably conclude that it is cool. But once you start thinking about how you would actually administer something like this and then read the details of how the AFA plans to administer this, it is not very cool at all.
The reason why we wait until tax time to send out refundable tax credits is because we cannot know how much the refund should be until we know what someone’s tax liability is. And we cannot know what someone’s tax liability is until we know what their income situation was for the year.
To provide a refund in advance, we therefore have to rely on people to estimate in advance what their tax liability for the year is going to be and then report that estimate to the IRS.
Put another way: to make this program work, people will need to file what amounts to two tax returns every year, one speculative one at the beginning of the year, and one real one at the end of the year.
This is of course a ridiculous administrative ordeal to place upon anyone, but more importantly it is the kind of administrative ordeal that many poor people will not be able to successfully navigate. It is already the case that over 1 in 5 eligible people fail to successfully apply for the Earned Income Tax Credit. And that only requires an end-of-year tax return based on actual income, not a beginning-of-year tax return based on speculative income.
In an addition to creating a heavy administrative burden, basing the payments on what people tell the IRS their expected tax liability is runs into an obvious problem: some people will just lowball their expected tax liability, intentionally or accidentally, causing them to receive potentially thousands of dollars of benefits that they are not actually eligible for.
To prevent this from happening, you have to monitor everyone who receives the advanced refunds to see if their real tax liability turns out to be higher than they estimated so that you can force anyone in that scenario to give the money back.
In the AFA, this lovely user experience would be administered through a surprise tax bill in the following year. Specifically, everyone whose income turned out to be higher than expected would have their advanced CTC refunds added to their tax bill. If you weren’t savvy enough to realize that your unexpectedly higher income would trigger this kind of clawback, you could find yourself on the hook for thousands of dollars that you may not have the funds to repay.
There are a lot of scenarios in which this kind of clawback will occur, some obvious, some not so obvious. For example, perhaps you begin the year thinking you are going to be “married filing jointly” but then you have a divorce near the end of the year and wind up filing as “single” or “head of household.” The tax brackets have all changed on you and so your estimated tax was wrong, making your advanced monthly refund wrong, potentially subjecting you to the clawback.
But even clawing back overpayments does not fully solve the improper-payment problem. After all, even if you expected that you would have a very high income for the year, it would still make sense to lowball your estimated tax liability in order to get the full CTC each month. If the high income materialized, then you can just put the CTC money in an interest-bearing account and pay back the principal (keeping the interest) at tax time. If the high income did not materialize, then you’d have the CTC available to you for real use.
In order to prevent this problem, you need to heap additional penalties on people who take advantage of the advanced monthly refunds in this way. In the AFA, the extra penalties are that you are disallowed from receiving any CTC benefits for 2 years if you are deemed to have claimed the credit “recklessly” and for 10 years if you are deemed to have claimed it “fraudulently.” These terms are not defined in the statute, so presumably it will turn on the IRS bureaucrats and federal judges to decide which families will have as much as a decade of their child benefits snatched from them.
This Already Failed
Just reading these details should be enough to conclude that this is going to be an administrative train wreck. But we don’t have to only speculate about it because this has already been tried and failed. Specifically, for about a decade in the early 2000s, it was possible to receive an advanced monthly refund for the Earned Income Tax Credit (EITC).
The program was a total disaster. Only 3 percent of eligible people signed up for it. And among those 3 percent, nearly 80 percent actually failed to comply with at least one of the program’s requirements, meaning that they had done things like filled out incomplete forms or never filed a tax return at the end of the year. The program was so bad that Obama proposed to eliminate it in 2010 and then did eliminate it in 2011.
No doubt some people will try to insist that this time it will be different. But those people should not be taken seriously. The same problems that plagued the Advanced EITC — administrative complexity and fear of clawbacks — are inherent to the advanced tax credit design.
Even if you did take these people seriously, there is still the question of how much different it would be. With a better implementation, instead of 3 percent participation in the program, you get 10 percent? Maybe, if we are dreaming, 50 percent? These are all disastrous outcomes.
The official phase-outs in the American Family Act are at $130,000 for a single filer and $180,000 for a married filer. After that point, the amount of credit you are eligible for declines by 5 cents for every dollar of incremental income.
Many reporters seem to think that this means that everyone who has less than $130,000 of annual income will get the full monthly check, which is $3,000 / 12 = $250/month. Since most people do not have income that high, all this clawback stuff may seem like it’s not going to affect that many people.
But this is wrong.
The advanced monthly refund is a tax refund. So you are only eligible for it if you have negative tax liability for the year and the monthly amount is based on precisely how much negative tax liability you expect to have. People are on the hook for $3,000 of federal income tax well before $130,000 of adjusted gross income.
To see what the phase-out of the monthly refund is (as opposed to what the phase-out of the credit is), I ran the AFA details through TAXSIM for 2021 for a one-parent, one-child family. This graph is the result.
For this family, the full $250 check is only available for individuals who earn less than $34,665 per year. After that point, the amount phases out by 28 percent and then by 12 percent at the very end. At $46,525 of earnings, the checks vanish.
Just imagine for a second a single mother who earns $46,525 per year, which is below the national average wage, who hears about this great new program where she can get $250 checks each month for her kid. She goes through the pain of filling out what amounts to a speculative tax return for the year, submits it to the IRS, and then they send back a letter that says they have determined she is ineligible for monthly checks.
Even worse than that, imagine a single mother earning $46,425 per year who does all this paperwork to sign up for this exciting new benefit and then the IRS sends her $1 per month. How do you think that will make her feel?
Imagine a single mother who predicted that she would earn about $34,000 for the year, which entitles her to the full $250 monthly refund. But she ended up earning $38,240 for the year. She did not realize she needed to update her monthly refund amount and so she ends up slapped with a $1,000 tax bill at the end of the year when the IRS claws back her excessive CTC payments. Does this woman have $1,000 to pay this bill? I’d bet not.
Of course in all these scenarios, you could try to explain to the angry person that they are actually benefiting from the full credit, just through lower total tax payments rather than a monthly check in their bank account. You could tell the woman hit with the surprise $1,000 bill that she is actually better off than in the prior regime, if you look at her final disposable income. How you would ever reach these people, let alone get them to wrap their head around something so complicated, is hard to fathom. Why you would want to create a program that requires this kind of explanation is even harder to fathom.
This is the kind of design you would do if your goal was to undermine the welfare state by generating resentment, not the kind of thing you would do if you really wanted to build a robust system of social benefits. User experience matters.
The alternative to all of this mess is obvious, but it bears repeating: stop using a tax credit to get money to children. We don’t use tax credits to get money to the elderly, or the disabled, or the unemployed. Instead we send these populations money through Social Security and Unemployment Insurance. That is the appropriate model for child benefits. Send every child in the country the exact same check every month (I argue for $374 but obviously it could be a different amount). You do not need to phase the benefit out and you sure as hell do not need to reduce the benefit by expected tax liability. Just send the money out and use normal income taxes to handle the rich.
Unlike the American Family Act proposal, this proposal really could be stood up almost immediately, as we saw just last year when the IRS sent out checks to nearly every person in the country. The design I am proposing would be even easier than that.