Simplifying Child Related Incentives in the Tax Code
By Elaine Maag :: April 14th, 2011
With only a weekend left to settle up with Uncle Sam, figuring out how much you owe (or stand to gain) is far from child’s play—particularly if you have kids.
Parents must wade through page after page of rules for the dependent exemption, head of household filing status, the Child Tax Credit (CTC), the Earned Income Tax Credit (EITC), college subsidies, and more. It’s enough to make you cry.
Nothing is tougher than figuring out which tax breaks your kids qualify you for. That’s partly because the definition of a child differs across provisions. While Congress simplified the rules in 2004, it didn’t fix the problem. As a result, a child must be under age 17 to get you the CTC but under 13 to let you claim the child care credit. For the dependent exemption, head of household filing status, and EITC, the age limit jumps to under 19—unless she’s a full-time student under 24 in school at least five months during the year. And the definition differs yet again for education benefits: the American Opportunity Tax Credit, Lifetime Learning Credits, and the tuition and fees deduction.
This maze creates two problems. Some confused parents erroneously file for benefits they are not entitled to, while others, overwhelmed by the complexity, may fail to take advantage of tax incentives designed to encourage work or schooling.
Just as important, this mess makes it hard for the IRS to administer the tax code without burdensome audits. The IRS doesn’t know, for example, whether your child was in school for enough hours and enough months to let you claim child credits and deductions.
Big dollars are at stake. The Tax Policy Center estimates that more than 48 million families will save $38 billion thanks to the dependent exemption. Most of the benefits go to families with incomes in the highest 40 percent. The Child Tax Credit will cut taxes by more than $50 billion for 35 million families; the bulk of those benefits go to the middle three-fifths of the income distribution. The EITC gives over $50 billion to more than 20 million families—95 percent in the bottom 40 percent.
Trouble is, these multiple child provisions perform overlapping functions: they subsidize children, encourage work, and promote college attendance. It would make a lot more sense to restructure these incentives so we subsidize work and children separately. The work credit could subsidize all low-wage workers (replacing part of the EITC), while a child credit could replace the dependent exemption, the CTC, the head of household filing status, and the rest of the EITC.
Fixing the wage credit is relatively simple. It would go to all low-income workers, regardless of whether they have children. Combining the child incentives is harder. A broad definition of child would make many more families eligible, but cost money the government does not have. A narrow definition would save money but penalize families whose children would be excluded.
I propose a hybrid solution. Create a uniform definition of child at under age 19 and eliminate the student exception. That would boost the cost of the CTC by $6.1 billion in 2011 but would save $7 billion by cutting the number of dependent exemptions, saving a net $0.9 billion. As “qualifying relatives,” some older students could still allow their parents to claim them as dependent exemptions and, if single, to file as heads of household. Eliminating eligibility for all 19- to 23-year-olds would raise net savings to $3.0 billion. We could use the savings to increase college subsidies for low-income students who would lose out on the EITC as a result of these changes.
This plan would not only jump start development of distinct child and worker incentives, but could also provide a stepping stone toward broader tax reform. It might even start that adult conversation our children are waiting for.