The Child Tax Credit Red Herring

T he signature tax bill of this Congress is currently winding its way through the legislative process. The “Tax Relief for American Workers and Families Act” (TRAFWA) is the result of bipartisan, bicameral negotiations primarily between House Ways and Means Committee chairman Jason Smith (R., Mo.) and Senate Finance Committee chairman Ron Wyden (D., Ore.). TRAFWA was reported out of the Ways and Means Committee 40–3, with all 25 panel Republicans voting in favor. In addition, over 150 House Republicans not on the Ways and Means Committee signed a “Dear Colleague” letter organized by Reprsentative Rudy Yakym (R., Ind.), urging the House to pass the “meat” of TRAFWA, the retroactive and prospective restoration of pro-growth cost-recovery provisions from the Tax Cuts and Jobs Act (TCJA) that expired ahead of the big TCJA sunset date at the end of 2025. It enjoys the support of the broad conservative fiscal and tax group community, as well as the downtown employer trade associations and companies.

In recent days, there’s been some griping about what Chairman Wyden got as his half of the TRAFWA agreement: an expansion of the child tax credit. Those doing so should remember that the reason why Chairman Smith had to deal with Chairman Wyden instead of Ranking Member Wyden is because Republicans failed to retain control of the U.S. Senate in the 2020 elections and failed to retake the U.S. Senate in the 2022 elections. Elections have consequences. If absolutely essential cost-recovery tax reforms were to be restored to the tax code, the Democrats earned a gavel and got to have a win, too. In the future, if Republicans want to negotiate only with fellow Republicans, they should win both chambers of Congress at the very least, and also the White House. As it is, the GOP barely governs the one chamber it purportedly controls, the U.S. House. The fact that Chairman Smith was able to negotiate as good a tax bill as he has from such a weak hand should be commended, not nitpicked to death.

The TRAFWA bill expands the child tax credit (which has a Republican pedigree going back to the Contract with America, and was expanded by George W. Bush and Donald Trump) in three ways.

First, the $2,000 per child tax credit established by TCJA beginning in 2018 is to be indexed to inflation starting in 2024. The refundable portion of the child credit (that is, the amount a filer gets even if their income-tax liability has already been zeroed out) was indexed to inflation by the TCJA and currently stands at $1,600. This latter amount is increased by $100 per year over the next few years, but it never catches up to the now-indexed tax credit in general. If made permanent, the child tax credit and its smaller refundable component would grow with inflation over time, an obvious pro-family, pro-taxpayer benefit.

The second child tax credit expansion in TRAFWA has been panned by the Wall Street Journal editorial page, fairly absurdly. There is a work requirement in the child tax credit that is currently applied annually. Under the bill, if the taxpayer has lower or no income in a year, she is allowed to use her immediate prior year’s earnings in calculating the refundable child tax credit. This is meant to protect lower-income people from job loss, illness, or leaving the workforce to raise a child.

The fear is that low-income single mothers will game the system and “zigzag” in and out of the workforce every other year. To believe this, you have to envision a single mom employed at a fast-food restaurant working a full-time $20,000 job in Year A, quitting this job in Year B and earning $0 as a result, all for the sake of collecting a $2,000 or $4,000 refundable credit in the spring of Year C. If you think human beings act this way, you don’t believe in our species as rational creatures. Who would take that deal?

The third and most substantial expansion of the child tax credit in TRAFWA involves the calculation of the work requirement. Under current law, the credit’s refundability requires the taxpayer to earn $2,500 of wages or other earned income even to get into the ball game. From there, every $100 earned over $2,500 results in $15 of refundable credit. For example, a single mother earning $10,000 would qualify for a refundable credit of just $1,125 ($10,000 minus the $2,500 hurdle amount times 15 percent). In order to qualify for a refundable credit for two or more children, the single mother must continue to earn wages, accruing the 15 percent as she continues to earn.

Under TRAFWA, our single mother with two kids earning $10,000 would qualify for a refundable credit of $2,250 (the old formula times two children). The phase-in counts concurrently for each child, not sequentially. It’s more than a technical change, and it’s a lot of money for low-income people (it’s also a hell of a work incentive at the low end of the wage scale, as each extra dollar earned for our single mother with two kids used to benefit her $1.15, but now does it to the tune of $1.30). However, the new rules don’t substantively change the fact that in order to get the child tax credit on a refundable basis, one has to have a real job with lots of hours and earnings.

Here’s what the three expansions of the child tax credit under TRAFWA do not do: They do not create or enhance “anchor babies” (the requirement for a Social Security number imposed by TCJA remains totally unchanged, and there are several Senate Republicans who don’t want to see these rules tightened further). They do not result in substantial labor-market changes (so says the tax expert at AEI, as well as the Tax Foundation), and lookback calculations are a common tactic in bills which have enjoyed broad bipartisan support. The child tax credit has been refundable ever since the original Bush tax cut of 2001 — nearly a quarter century — and should not be confused with the advanced-payment welfare checks that the Democrats managed to pass in 2021 (those suddenly existentially opposed to refundability have decades of explaining to do). The refunds issued by the IRS will happen as they always do in the spring and very early summer of this year — not the October “election surprise” that has been whispered around town. It doesn’t untether the child tax credit from payroll tax liability. (They were never connected in the first place.)

Those who have said these child tax credit expansions are unacceptable should be reminded that this is not the first version of a major tax bill Chairman Smith’s Ways and Means Committee has advanced. In June of 2023, the committee reported H.R. 3936, the “Tax Cuts for Working Families Act.” It did not have an expansion of the child tax credit. Rather, it grew the standard deduction, an action that has no refundable tax implications directly and only benefits income-tax payers by definition. This standard deduction boost was panned by the Heritage Foundation and others for reasons that remain unclear, not the least of which is the fact that these same groups supported the standard deduction being doubled in TCJA. At the time, they were warned that the alternative to standard-deduction tax relief was not tax-reform nirvana, but rather a Senate Democrat demand for refundable child tax credit expansion. And here we are.

The reason we are dealing with tax-code provisions on the near-literal eve of tax-filing season is because Democrats were, up until this time, demanding far too much in child tax credit expansion. They wanted to enshrine in law the version of the credit they managed to enact under Democratic-only government in 2021 alone: a much larger dollar amount ($3,600 for younger children, $3,000 for others), indexed to inflation, fully refundable, with neither work nor citizenship requirements, and paid out in advance in the form of welfare-like monthly checks from the IRS. The Democrats came down tremendously from their original demands, and what remains is a fairly standard modest enhancement of the refundable part of the credit one might expect to come out of a sane, bipartisan negotiation. Again, Chairman Smith is to be commended for hammering out a good deal.

It’s important that congressional Republicans not lose sight of the fact that this is a bill to extend Trump’s TCJA tax cuts, not to radically expand the child tax credit. President Biden signing into law an extension of the tax law he vowed to repeal if elected is a major win, sets the chessboard for TCJA permanency or extension in 2025, and enshrines into law a consumption-tax-style, cash-flow-tax base that is second in importance only to low tax rates on work, savings, and investment when it comes to conservative tax reforms from the flat tax to the FAIR Tax to anything in between. It’s common sense to pass TRAFWA, and Congress should do so immediately.