The Real Economy

Child tax credit: Potential game changer for American families

Oct 04, 2021
Economics The Real Economy

One aspect of the American Rescue Plan signed into law in March included an extension of the child tax credit, first enacted in 1997, to send direct aid to families.

Those aid checks, for families with children making up to $150,000 for a couple or $112,500 for a single parent who is head of household, began arriving in American family pocketbooks during the week of July 15. They will provide an additional boost to overall spending at a time of rising risks to the spending outlook linked to the spread of the delta variant.

Now that child tax credit could be made permanent if the House and Senate pass the measure.

We estimate that the expanded child tax credit already approved will result in a roughly $35 billion increase in consumer spending over the next year, bolstering both employment and business growth.

This is based on estimates by the congressional Joint Committee on Taxation and an assumption of a fiscal 1.4 multiplier, which is consistent with the 1.22 fiscal multiplier for lump-sum payments during the Great Recession.

The expanded child tax credit provides aid for the most part to the three lowest quintiles of income earners—or those who tend to spend any additional income that comes their way.

We think that the economic shock and the follow-on policy support by both the fiscal and monetary authorities create the conditions for a modestly higher fiscal multiplier given the already elevated level of savings. Conditions are ripe for the more modest increase in spending implied by our estimate.

The extension of the tax credit increases payments from $2,000 to $3,000 per child for children over the age of 6 and from $2,000 to $3,600 for children under the age of 6, and raises the age limit from 16 to 17.

Since the legislation increases payment amounts, expands eligibility and makes the credit fully refundable –previously it was only partially refundable—it will increase aid to families and boost overall economic activity.

The direct objective of the expanded child tax credit is to reduce poverty and secure a direct flow of aid to families to meet daily costs.

Perhaps more important, half of the credit is being directly disbursed to families in the current calendar year. This program provides aid for the most part to the three lowest quintiles of income earners, including the beleaguered American middle class.

The direct objective is to reduce poverty and secure a direct flow of aid to families to meet daily costs. According to the Congressional Research Service, the expansion of the child tax credit will reduce the child poverty rate from 13% to 7%. Based on that group’s scholarship, 96% of families with children will benefit from the expanded credit, up from 84% previously.

Because almost all of the direct cash payments are going to low- and middle-income households, recipients will have a higher marginal propensity to consume all the additional income and save little of it. Most of the cash payments will be spent bolstering growth in the national and local economies.

The credit then declines with families above the income limits. It is phased out for couples with two children earning $480,000 and for single-parent households above $280,000, with some variation around top income levels depending on the number of children in the household.

Costs and benefits

The Congressional Budget Office estimates that it will cost the federal government more than $100 billion once lost revenue and increased outlays are accounted for.

But research conducted by the Center on Poverty and Social Policy at Columbia University estimates that the federal government will recapture most of those costs through lower outlays on health care and crime prevention, and through increased future tax revenues linked to the child tax credit.

Why is that? Because the research shows that the long-term benefits of the child tax credit include higher future lifetime earnings and improved health-related outcomes that are roughly eight times larger than the costs of the program.

Here is how it works: A hypothetical family with $100,000 in annual income with two children under six now receives a child tax credit of $7,200. That is an increase from $4,000 previously. But unlike the previous lump-sum benefit that was taken when filing taxes, the household now receives half ($3,600) of the total benefit in six monthly installments of $600 between July 2021 and December 2021. They then receive the balance ($3,600) of the tax credit when filing their 2021 tax return in 2022.

This program is authorized only through December, with the remaining balance of the credit to be disbursed by the spring of next year. So extending the tax credit will be part of the policy narrative and budgetary debate heading into the midterm elections next year.

The cost of making the extension of the tax credit permanent will be large. Congress and the administration should consider tax and spending measures to support it if lawmakers decide to reauthorize the program. But the long-term benefits of investment in such social infrastructure should be integrated into any cost-benefit analysis. In our estimation, the fiscal authority should strongly consider making this program permanent.

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