How low-income tax credits might be improved

The federal tax code of the United States has many purposes—the main one, of course, being to help fund the federal government. Yet it also helps determine the shape and level of income inequality, both before and after income is redistributed. Most conversations about the tax code invariably drift to the subject of top marginal tax rates and their effects on economic growth and inequality. But the tax code has become not only a tool to take in money from households, but also a way to give them money.

As the federal government has placed less emphasis on dispersing cash in the form of traditional welfare, it has instead begun handing out cash through tax code programs like the Earned Income Tax Credit or the Child Tax Credit—the major tax code provisions that are oriented toward the lower half of the income distribution. A new working paper by economists Hilary Hoynes and Jesse Rothstein of the University of California, Berkeley takes a deeper look at the two tax credits, showing that while they accomplish many of their goals, they can be improved even further.

The Earned Income Tax Credit has come to replace traditional welfare programs as the major poverty-fighting cash-transfer program. In other words, the program is explicitly about redistributing funds toward those at the low end of the wage distribution. But the Child Tax Credit, while in theory targeting the low end of the distribution and amplifying some of the effects of the Earned Income Tax Credit, seems more focused on “horizontal” concerns by reducing taxes for families with children compared to those without them.

One concern about the Child Tax Credit is that it’s not “fully refundable.” Whereas a person can get the full value of the Earned Income Tax Credit even if they don’t pay any federal income tax, the Child Tax Credit is only refundable for people with annual incomes over a certain level. Thanks to a 2009 reform made permanent in 2015, that income level is now only $3,000 instead of the previous threshold of $11,500.

But even with that reform, the Child Tax Credit is still far less targeted at low-income workers than the Earned Income Tax Credit. According to Hoynes and Rothstein’s calculations using a tax model, 60 percent of the benefits of Earned Income Tax Credit goes to tax filers earning less than $30,000 a year. On the other hand, only about 20 percent of Child Tax Credit benefits go to this group—and another 20 percent of the benefits from the credit goes to families making more than $100,000 a year.

Lowering the income threshold, however, made the Child Tax Credit much more progressive: More than 70 percent of the new benefits went to families making less than $30,000 a year. Making the tax credit fully refundable like the Earned Income Tax Credit would further increase its progressivity. Likewise, policymakers could also make the Earned Income Tax Credit more progressive by expanding the credit for workers without children.

Again, both the Earned Income Tax Credit and the Child Tax Credit have been successful at achieving their stated goals. But Hoynes and Rothstein’s research reminds us that just because a program may work well, that doesn’t mean it can’t work better.