Romney floats ‘child allowance’ in reform of child tax credit

BY KYLE POMERLEAU

Last month, Senator Mitt Romney introduced a proposal to enact a “child allowance,” a monthly payment to households with children. His proposal would be financed in part by repealing other child benefits, including the “Child and Dependent Care Tax Credit” (CDCTC). Many critics of the CDCTC claim that repealing it would reduce a bias in favor of working parents with formal childcare arrangements over stay-at-home parents. In reality, however, repealing the CDCTC would exacerbate the tax system’s current bias against working parents.

The CDCTC is a nonrefundable credit equal to 20 to 35 percent of “qualifying” child and dependent care expenses. Taxpayers can claim the credit for up to $3,000 in expenses per child but no more than $6,000 in total. The credit is available only to taxpayers who are working or looking for work.

The argument that the CDCTC is biased against stay-at-home parents is mistaken because it ignores the impact that income and payroll taxes have on working parents with formal childcare arrangements. In fact, the CDCTC helps maintain tax neutrality between formal childcare and stay-at-home parents.

To see how this works, first suppose that there were no taxes at all. A parent would decide — based on market wages, the cost of childcare, and personal preferences — whether to work and pay for childcare or stay home and provide childcare service to themselves. Because neither activity faces taxation, there would be no bias in favor of either activity.

Next, consider the impact of income and payroll taxes. The parent still faces a choice between working and paying for childcare and staying home and taking care of their child, but the tax system introduces a bias into the decision. Working and paying for childcare results in tax liability while staying home is untaxed.

A policy that reduces the tax on the working parent can therefore reduce the bias against work and move the tax system toward neutrality.

The CDCTC is surely imperfect, but it does help equalize the treatment of working parents relative to stay-at-home parents by offsetting the penalty created by the income and payroll tax. Reforms or expansions of the CDCTC have been proposed by President Biden and recently considered by the House Ways and Means Committee. On the margin, such reforms are likely to bolster economic growth.