Josh McCabe has a piece at the Niskanen Center defending the idea of using a child tax credit to deliver benefits to children. His post makes a number of mistakes and omissions that policymakers should be aware of.
Phase-out Problems
The bill that Joe Biden’s CTC proposal is based on, the American Family Act, applies two phase-outs based on an individual’s estimated income for the year.
The first phase-out is a phase-out for the total credit amount, which kicks in at $130,000 for a single filer and $180,000 for a married filer.
The second phase-out is a phase-out for the advanced monthly refund, which kicks in at a variety of locations depending on income and tax filing status. For a single mother with one kid, it kicks in at $34,665 of earnings, as we see in the graph below.
There are two main problems with this design:
- To apply a phase-out based on expected income, people have to report their expected income, which they do not currently do. This amounts to requiring people to file two tax returns a year, a real one and a speculative one. This administrative burden will result in many eligible people not receiving the benefit they are eligible for.
- To apply a phase-out based on expected income to the advanced monthly refund, you have to clawback overpayments at the end of the year, creating serious hardship for those who were unaware that their unexpectedly higher income would result in a surprise tax bill of thousands of dollars.
To defend a child tax credit designed in this way, McCabe simply ignores the first problem. He makes no response to it. So to reiterate here: this design will exclude some poor people because they will fail to jump through these unnecessary administrative hoops.
For the second problem, McCabe concedes that it is a serious problem in the American Family Act, but then says that it won’t be an issue because the real bill that passes will eliminate the phase-out on the advanced monthly refund and only keep the phase-out for the total credit.
He concedes that the overpayment problem will still exist even if you only keep the phase-out for the total credit. But says it will not ding as many people because the phase-out for the total credit starts at a much higher income level.
It’s unclear why he believes they will get rid of the advanced monthly refund phase-out. They have had years to get rid of it and they haven’t, either by dropping a new bill or by publicly indicating any intent to do that. But even if they do, as he himself notes, this completely unnecessary phase-out will lead to overpayment clawbacks for some people.
Additionally, it is weird to solve the problem caused by the phase-out by starting the phase-out way up the income ladder. It’s true that if you only phase it out on the top 5 percent of families that the number of people who could be dinged by overpayments and clawbacks becomes relatively low. But it’s also true that a phase-out that high up the income ladder isn’t saving any meaningful money. So what’s the point? It’s a bunch of administrative headache for nothing.
Also Bad In Other Countries
McCabe finishes his piece by saying that these criticisms ignore that a lot of countries successfully use child tax credits to administer these programs, which he then clarifies as meaning that Anglo countries do it.
But the benefits in these other Anglo countries have also sucked, both historically and at present.
The United Kingdom implemented a child benefit with the exact same structure being proposed here. Shortly after it was implemented, they discovered that one-third of all benefits were overpaid, i.e. paid to people who had underestimated their income and therefore got more child benefits than they should have. This led to crushing “welfare debt” that had to be repaid, which became a real political problem.
From 2003, there were substantial and very visible problems with overpayments, or more precisely visible problems in terms of the impact on claimants of having to repay overpayments. The number of overpayments, and their costs, were much higher than predicted. In the first year (2003/04), about one-third of all tax credits awards paid – nearly 1.9 million awards – were overpaid, at a cost of nearly £2 billion (House of Commons Treasury Select Committee, 2006). Media coverage reported confusion, hardship and debt as the government sought to recover overpayments.
They tried to fix this problem by disregarding the first £25,000 of income someone received beyond what they estimated they would receive in order to cut down on clawbacks. This reduced clawbacks, but clawbacks still occurred for some. Later on, this income disregard was reduced because it was decided it was causing the government to waste too much money paying out benefits that were not actually owed. This move spiked clawbacks yet again.
More recently, this credit was folded into the UK’s Universal Credit regime. The Universal Credit has overpayment and clawback problems right now.
In Australia, the Family Tax Benefit had the exact same problems the United Kingdom had. Because the benefit was phased out based on estimated income, a large number of overpayments resulted, creating punishing welfare debts that had to be repaid.
Controversy about the new system started towards the end of the 2000–2001 financial year, when the time first approached for reconciling entitlements. In 1999–2000, there had been about 51,800 families with debts at the end of the year. In contrast, after the introduction of the new system, an estimated 670,000 families were overpaid – more than 12 times as many as the previous year.
As in the UK, Australia initially attempted to solve this problem by disregarding some of the overpayment amounts each year. This helped some but there were still enough complaints for the government to take one more stab at, this time by creating a second Family Tax Benefit that would only be paid out as a lump sum at the end of the year, rather than paid out as an advanced monthly amount. This lump sum would offset lump sums that people owed from overpayments, reducing the headache caused by overpayment. This “solved” the problem only in the sense that they simply gave up on providing (part of) the benefit monthly.
In Canada, they have avoided these problems by basing each family’s monthly benefit on their actual income from the prior year rather than their estimated income for the current year. This means that you cannot receive an overpayment. It also means that you do not need to file a second tax return estimating your income for the year.
I would agree that this is an improvement overall on what the other Anglos have done and what the US appears to be setting up to do, but it has its own unique problem: families who had a high income last year but a low income this year do not receive the child benefits they need to stay afloat. Put differently, due to income volatility, the child benefit amounts are not actually being correctly targeted to those who currently need them.
All Of This Can Be Fixed
The Keystone Cops routine of Anglo countries trying to make this structure work tells you everything you need to know about why we should not structure the US child benefit this way. And there is an alternative that has none of these problems: the Nordic-style universal child benefit where every family gets the same amount of money sent to them every month for every child they have. This involves the least amount of administrative burden and results in no overpayments for anyone. It has no downsides relative to the child tax credit approach. It’s simply better.
At the end of his piece McCabe basically gives away the game here, which is to say that in his view it is not politically wise to attack an inferior design at this juncture:
We are at a critical juncture in the evolution of benefits for American children. Biden’s proposal has the potential to tackle child poverty in a serious manner. It would be a mistake to get sidetracked by baseless claims about the relative merits of administration of those benefits as refundable tax credits.
But this is precisely the time to do it. The US government does not have many opportunities to change things after they have been implemented. We saw this with Obamacare. There were many little tweaks you could have done to Obamacare after it was implemented that would have cleared up some problems that revealed themselves. But the legislative majorities to make even small tweaks had disappeared and we were stuck with a creaking system that still to this day has a hole where some people are too rich for Medicaid but too poor for the Exchanges.
It is precisely when we are on the precipice of passing a something like this that every expert needs to speak up and make sure the policymakers design this thing correctly.