Tax Relief for Child Care Should Be Maintained

March 6, 2013

As state legislators grapple with their fiscal situations, many states are considering reducing individual income tax credits and deductions. Altering these credits and deductions could disproportionately affect children and families who depend on the tax relief offered for child and dependent care costs. Because income tax relief for child care helps parents recoup the costs of not earning taxable income, state lawmakers should leave these credits and deductions intact, say Alan Viard and Veronika Polakova of the American Enterprise Institute.

  • There is debate over whether governments should tax different goods at different rates, and whether differential tax rates reduce inequality and incentives to work.
  • Tax relief for work-related goods promotes economic neutrality.
  • By offsetting disproportionate reductions and discouraging work, tax relief balances larger reductions in the purchases of other goods.

Child care merits tax relief because labor economists have proven that reductions in the cost of child care lead to increased work. Because stay-at-home parents do not incur income and payroll taxes, tax relief provided to working parents for child care maintains economic neutrality.  Proponents of the child care credit claim that abolishing the credit would harm two-earner couples and single working women.

  • The federal tax credit is equal to 35 percent of creditable expenses for taxpayers with an adjusted gross income below $15,000; the rate declines 1 percent for each additional $2,000 earned up to a minimum 20 percent for taxpayers with incomes of $43,001 or greater.
  • The credit applies to children under age 12 or disabled individuals of any age.
  • The federal credit does not reimburse taxpayers enough to cover child care costs and steps should be taken to ensure that the dollar limits and refundability are increased.

Thirty-four of the 42 states with income taxes offered some form of income tax relief for child care costs in 2011. The relief is typically offered as a credit for easy calculation and 18 states have pegged their level of relief to a percentage of the federal credit.

  • States that do not currently provide relief should subsidize child care costs.
  • States that currently offer multiple tax relief provisions should consolidate their offerings to reduce complexity.
  • States should also set higher and more realistic limits for child care costs above the federal limits of $3,000 and $6,000.

Doing so would result in increased economic efficiency and larger income and payroll tax revenues.

Source: Alan D. Viard and Veronika Polakova, "Cutting the Cost of Care: State Income Tax Relief for Child Care," American Enterprise Institute, March 4, 2013.

 

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