While there are a handful of tax credits and deductions within the tax code that support families with children, the only provision in the tax code created specifically to help families with the cost of child care is the Child and Dependent Care Tax Credit (CDCTC) – often referred to as the child care tax credit. The Child Tax Credit (CTC) is completely separate from the CDCTC. It is intended for families with dependent children and is designed to ensure the tax code reflects that families have more expenses and less disposable income than individuals and couples making the same amount without children. This is particularly important now, as families are struggling with the devastating economic impacts of the COVID-19 pandemic.
For years, the costs associated with quality child care have been rapidly outpacing other expenses faced by families, including the cost of housing and higher education. And the economic case for using the tax code to provide relief for families struggling with the cost of child care costs is straightforward, according to Alan D. Viard, resident scholar for federal tax and budget policy at the American Enterprise Institute (AEI). “If workers are taxed on their wages, they should receive tax relief for the costs they incur to earn the wages, just as businesses deduct the costs of earning the income on which they pay tax. There can be little doubt that child care costs are tied to work.”
The CDCTC was created in 1976 to help working families pay for qualified expenses associated with the care of children, as well as adult dependents. Congress approved a temporary increase to the credit in 2001, and in 2012 a bipartisan majority voted to make that permanent.
Today, the credit varies between 20 and 35 percent of qualified expenses up to $3,000 per eligible child. Qualified expenses are capped at $6,000. That means the maximum credit for working parents with two or more children is $2,100 (35% of $6,000) – only about 10 percent of the average annual cost of care for two children in the United States.
We know that early childhood education from birth through age five results in positive economic returns for families and society. However, as a nation, families struggle with high costs and a short supply of quality care options. Making the CDCTC a more robust tax incentive will help by making child care more affordable while encouraging expansion of the child care sector, resulting in increased access.
The CDCTC’s expense limits are also not indexed for inflation, so even as child care expenses have risen sharply since 2001, the credit has not changed to meet these increasing costs. What’s more, the credit is not currently refundable. As a result, most low- and some middle-income, tax-paying families are unable to take advantage of it. The Tax Policy Center found that nearly 40 percent of the credit’s value is claimed by families earning $100,000 or more, while almost no families in lower tax brackets were able to access the credit.
The CTC is available to American taxpayers for each qualifying dependent child who is under the age of 17 at the end of the tax year. And unlike the CDCTC, the CTC includes a refundable component, so if the value of the CTC is greater than the amount of federal income tax a family owes, the family can still receive part or all of the difference in the form of a refund check.
During tax reform in 2017, the CTC was increased to $2,000 per child, and is a powerful weapon against poverty. According to the Center on Budget and Policy Priorities, “the CTC lifted approximately 4.3 million people out of poverty in 2018, including about 2.3 million children, and lessened poverty for another 12 million people, including 5.8 million children.” Working and nonworking parents may use the CTC for any expense, even those not related to the costs of raising children.
As it relates to child care, however, only working parents pay taxes on the wages they earn and need tax relief for the child care costs that are directly associated with earning those wages. The CDCTC offers that assistance to working parents, thus providing families the chance to earn much-needed income, strengthen the American labor force, and ensure more children have access to high-quality early learning opportunities.