The 1997 Budget Deal - What It Means to Taxpayers

Policy Backgrounders | Taxes

No. 144
Wednesday, February 04, 1998
by Bruce Bartlett

Child Credit

"The budget would have been in near balance by 2002 without any budget deal."

The centerpiece of the tax package is the $500 per child tax credit, reducing the income tax liability for taxpayers with dependent children. While the bill does not limit the number of children to whom the credit may apply, it does limit the total amount of credit a taxpayer can claim. Also, for single taxpayers with adjusted gross incomes (AGI) above $75,000 and married couples with incomes above $110,000, the credit is reduced by $50 for each $1,000 of AGI above the threshold. The credit is not refundable.

It is not entirely clear where the idea for the child credit originated, and there is no economic rationale for it. Conservative groups had complained for several years about the "anti-family bias" in the tax code. However, this concern mainly centered on the erosion of the real value of the personal exemption.5 Unlike a tax credit, the personal exemption - which may be taken for each dependent - reduces taxable income by the amount of the exemption, rather than directly reducing one's tax liability. The value of the dependent personal exemption has declined in real terms by more than one-third over the last 50 years.6

"The centerpiece of the tax package is the $500 per child tax credit."

In 1991 the National Commission on Children proposed a $1,000 refundable tax credit for all children.7 This was intended as a modified negative income tax that would replace other parts of the tax and welfare systems. Economists Eugene Steuerle and Jason Juffras, authors of the $1,000 credit proposal, explained its need as follows:8

  • Households with children have borne more than their share of tax increases in the past decade.
  • Children with equal needs do not receive equal treatment in the welfare system, violating a basic principle of fairness.
  • The welfare and tax systems together create strong disincentives for low-income parents to work, marry or move to find a job.

Shortly thereafter, conservatives began turning away from personal exemption increases, adopting the tax credit approach instead.9 Subsequently, the tax credit became a top legislative priority for Christian and pro-family groups that are important to the Republican Party. These groups saw the child credit as a means of allowing working mothers and fathers to spend less time at work and more time with their children.10 Eventually, congressional Republicans officially adopted a $500 child credit as part of their "Contract With America."

When Republicans took control of Congress, enactment of the child credit became a high priority. On March 21, 1995, early in the 104th Congress, the House Ways and Means Committee reported a bill embodying provisions of the contract. The child credit provision would have allowed a $500 credit for taxpayers with incomes up to $200,000.

It is still not clear why the child credit, rather than an increase in the personal exemption, became official Republican tax policy. In previous years, Republicans had opposed tax credits on principle in favor of deductions and exemptions.

Tax exemptions and tax credits have very different effects; the value of the former depends on marginal tax rates, while the value of the latter does not. When one receives an exemption, taxable income is reduced by that amount. Thus the tax saving is a function of one's marginal tax rate - and the higher the marginal tax rate, the greater the value of the exemption. In the case of a tax credit, taxable income is unchanged but one's tax liability is reduced by the amount of the credit. Marginal tax rates do not affect its value.

Furthermore, for taxpayers at the income threshold for a higher tax bracket, an exemption or deduction might result in a lower marginal tax rate by reducing taxable income below the threshold, but a tax credit will not. The tax credit is phased out for higher-income taxpayers, in a way that increases marginal tax rates for single taxpayers with AGIs above $75,000 and joint-filers earning more than $110,000.

The child credit was sold primarily as an issue of social policy. Its primary economic effect was to use up three-fifths of all the revenue allocated for the entire tax package, which foreclosed the possibility of other broad-based tax cuts in 1997.

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