Many working parents — particularly those with pre-school aged children — struggle with the high costs of childcare, which can exceed rent and college tuition in some states. Currently, the Internal Revenue Code (the “Code”) contains an alphabet soup of tax benefits that parents with dependent children may claim. Working poor parents may receive substantial (which is not to say adequate) tax benefits under the refundable Earned Income Tax Credit (the EITC) and the refundable Additional Child Tax Credit (the ACTC). Many parents — even those not in or near poverty — may benefit from the child tax credit (the CTC) and even more may claim personal exemptions (which are generally not acronymized).
But none of these tax benefits depend on whether or to what extent families incur childcare expenses to work outside the home. They therefore, do not differentiate between otherwise similarly situated families — i.e. those earning the same income, filing under the same status, and raising the same number of dependent children — with different childcare needs. To reflect the varying costs of childcare, the United States could tax the so-called imputed income generated from non-paid care arrangements, such as the value produced when parents care for their own children or secure care through relatives and neighbors. It has, however, never endeavored to do so.
Instead, to reflect childcare costs, the Code provides relief to working parents primarily through two mechanisms. Parents may claim a “child and dependent care credit,” which allows parents to subtract from their tax liability a portion of the childcare expenses they incur to be “gainfully employed.” And parents whose employers have established qualifying “dependent care assistance programs” may be able to claim a “dependent care exclusion,” which allows them to exclude from their taxable income a portion of the otherwise taxable childcare benefits they receive. To cite one common example, employers frequently establish “dependent care flexible spending arrangements” (FSAs) into which employees may set aside a portion of their pre-tax earnings to pay for the childcare expenses they incur to work.
These childcare tax laws have the potential to correct the inequities produced by the Code’s failure to tax the value of internal, non-paid care arrangements. But due to a combination of dollar limitations and income phase-downs, many working families will receive tax relief for only a fraction of the childcare costs they actually incur, particularly in the critical years before children can attend school full-time. Moreover, parents of lesser means cannot receive refunds to reflect childcare tax benefits they do not have sufficient income to absorb. As a result, the Code does not equitably tax otherwise similarly situated families with different childcare needs.
Our childcare tax laws have not always been this limiting. In fact, after significant reforms in the late-seventies through the mid-eighties, the Code allowed many working parents to claim relief for a relatively substantial portion of their childcare costs, though childcare tax benefits have never been refundable. But since the mid-eighties, the childcare credit’s dollar limitations have been adjusted exactly once — in 2001 — and not even enough to compensate for the effects of inflation since their last modification about twenty years earlier. The dependent and child care exclusion’s dollar limits have not been adjusted since the mid-eighties. Thus, over the past decades, the benefits available under the childcare tax laws have remained largely static in nominal terms. Yet these benefits are steadily losing real value, since childcare costs have risen to (at least) reflect inflation. As a result, the inequitable taxation of families with different childcare needs continues to deepen.
Plans to improve the plight of the American family abound. Perhaps reflecting today’s political environment, recent proposals span historical extremes. During their recent Presidential runs, for instance, politically liberal candidates such as Hillary Rodham Clinton, Bernie Sanders, and Jill Stein proposed both tax and non-tax reforms that would help parents access quality and affordable childcare. Last month, Democratic Senator Patty Murray and Representative Robert C. Scott introduced the Child Care for Working Families Act, which builds off of Clinton’s proposal and aspires to “address the current early learning and care crisis by ensuring that no family under 150% of state median income pays more than seven percent of their income on child care.” Each of these proposals advocate for some sort of universal childcare program, envisioning an expanded role for the American government to play in the lives of parents.
At an opposite historical extreme, some politically conservative plans seem to put the childcare tax laws’ future existence in question. Most recently, the so-called Big Six — Senators Hatch and McConnell, Congressmen Ryan and Brady, Treasury Secretary Mnuchin, and National Economic Council Director Gary Cohn — released a “Unified Framework for Fixing Our Broken Tax Code,” which outlines a vision for tax reform in (very) broad strokes. The Framework devotes three of its nine pages to reforms that it claims provide “Tax Relief and Simplification for American Families.”
Because the Framework lacks critical detail (or, in the words of the Big Six, is intended as a “template for the tax-writing committees”), the effects it could have on any particular family are too varied and hypothetical to summarize here. Nevertheless, nothing in it would halt the continuing erosion of childcare tax benefits or address the inequitable taxation of families with different childcare needs. In fact, it’s not entirely clear whether or not the Big Six intend the childcare tax laws to be repealed.
The Big Six propose, among other things, to “consolidate” tax rates and eliminate the personal exemption (which depends on the number of dependent children in the taxpayer’s care, though not on whether childcare costs are incurred to provide that care). But it almost doubles the standard deduction (which does not depend on whether one has children at all) and substantially increases the CTC (which, like the personal exemption, is based on number of dependent children, but not on actual childcare outlays). The Framework does not mention the childcare tax laws by name but makes a general promise to repeal “[n]umerous other exemptions, deductions and credits . . . [that] riddle the tax code,” while specifying that certain politically sacrosanct benefits, like the charitable contribution and home mortgage interest deductions, will remain in place. It is, therefore, not clear whether the Big Six intend to include the childcare tax laws on the chopping block or just have them devolve further with inflation.
Of course, this will ultimately be up to Congress. Two recent proposals provide some tea leaves to read: the Tax Reform Act of 2014 (a nearly one thousand-page bill introduced by then Republican Congressperson Dave Camp as Chairman of the House Ways and Means Committee and often referred to as the “Camp Bill”) and “A Better Way” Blueprint (a far shorter, thirty-five page outline released in June 2016, and developed by a special “Tax Reform Task Force” alongside the House Ways and Means Committee under the direction of Republican Speaker of the House and Big Six member Paul Ryan).
Like the Framework, both the Camp Bill and the Blueprint would have flattened tax rates, eliminated the personal exemption and expanded the standard deduction and CTC. The Better Way Blueprint takes the same approach as the Framework, vaguely foreshadowing the repeal of unspecified deductions and exemptions while carving out sacred provisions such as the deductions for charitable giving and home mortgage interest. But the Camp Bill (by far the more detailed of the plans) goes further, proposing to repeal the childcare credit, speciously claiming that it “overlaps with other tax provisions that provide tax benefits for families.” Meanwhile, as I read it, the Camp Bill would have retained the dependent care exclusion (though it is not clear why the reasoning for eliminating the childcare credit, such as it is, would not have also led to the elimination of the exclusion, since they largely serve the same purpose). And because the exclusion’s value increases with the taxpayer’s marginal tax rate and is only available to parents whose employers have established certain programs, it appears that the Camp Bill would have — for no discernible reason — retained existing childcare tax benefits for some working parents but not others.
Thus, the Camp Bill’s “repeal approach” would not only fail to address but also enhance current inequities. The Blueprint’s “do nothing” approach might not exacerbate tax inequities as much. Yet it still does nothing to halt the childcare tax law’s devolution or actually address the inequitable taxation of otherwise similarly situated families with different childcare needs (which worsens over time).
Writing in this more informal format, I’ll resist the tradition of formulating my own specific proposal. Instead, I’ll note that if Congress were to make even modest adjustments to the childcare tax laws, it might enact historically significant reform that at least recognizes the tax inequities discussed. One doesn’t have to look far for ideas. In the most recently completed Congress alone, at least 24 different proposed bills to modify (and generally liberalize) the childcare tax laws were introduced to Committee. But they generally perished there.
Lawmakers submitted proposals to increase and even repeal the childcare tax credit’s income phase-downs. Other submitted proposals would make the childcare tax credit available as an above-the-line deduction (which has the potential to drive debates about why childcare expenses are not treated more like costs of earning income, though is problematic in several respects that have been noted by others). Another proposal would raise the percentage credit available when care involves young children (reflecting the fact that the cost of care is generally highest in pre-school years). Still others would raise significantly the dollar caps on either or both the childcare credit and/or dependent care exclusion. Some would have designated dollar caps automatically ratchet up for inflation each year without the need for additional action (a move that would at least halt the further devolution of childcare tax benefits). Another would break new ground by making childcare tax benefits refundable.
Such reforms may not garner “three cheers” from those advocating for more systemic reforms, such as universal preschool. And modest adjustments to our childcare tax laws are unlikely to solve system-wide problems on their own. But such reforms could nevertheless move the law in directions that have been historically resisted, reduce the inequitable taxation of families with different childcare needs, and perhaps even revive dormant debates about the role the American government should play in the lives of parents.
This Blog post draws substantially from Weeks McCormack’s current work-in progress, tentatively titled America’s (D)evolving Childcare Tax Laws, a draft of which is available upon request.