Child tax credit will lower economic growth and penalize marriage and work

One of the centerpieces of  Gov. Walz’ “One Minnesota” budget is his proposal to spend $1.1 billion over two years on a child tax credit for low income families. The credit would be for $1,000 per child with a maximum credit of $3,000 and would apply to families earning $50,000 or less or single parents earning $33,000 or less: after these thresholds, the credit phases out by $100 for each additional $1,000 in income.

Joshua McCabe of the Niskanen Center notes that:

The maximum credit amount is generous and reaches a broader age range than most other state credits. Among states with similar CTCs, credit amounts range from $100 to $1,000 per child. The more generous credits tend to limit eligibility to children under six. Minnesota’s CTC would extend to all children under eighteen years old and some disabled adults. 

The credit is indexed, which means it will  automatically adjust each year to prevent its real value from being eroded by inflation. 

The credit would be fully refundable, meaning that families can claim the credit regardless of their income or tax liability. Together with the proposed child care tax credit, this measure would eliminate state income tax liability for a large number of Minnesotans beyond the lowest earning 30% who, in total, currently pay no state income tax: that number could plausibly rise to 40% or 50%.

Nobody doubts that handing people thousands of dollars can have some palliative effect, but, economist Scott Hodge asked recently, “does it truly improve long-term living standards?” Looking at the proposal to expand the federal child tax credit, Hodge’s answer is:

No. On the contrary, recent studies estimating the economic effects of the proposed expansion suggest that it would cause people to leave the workforce, reduce work effort, and lower capital investment, ultimately shrinking economic output.

A recent study by economists at the University of Chicago determined that without any changes in behavior, expanding the credit would reduce child poverty by 34% and “deep” child poverty—families whose income is less than half the poverty level—by 39%. But those gains would come at a cost: the diminution of the workforce by 1.5 million people. Consequently, fewer working parents would diminish the child tax credit’s impact on reducing child poverty by more than a third, to 22% from the initial estimate of 34%.

The child tax credit is a drain not only on the federal budget but on the nation’s economy. [Joint Committee on Taxation]’s economic models predict that over a decade the policy would reduce the labor supply by 0.2% and reduce the amount of capital by 0.4%. As a result of the reduced supply of labor and capital investment, gross domestic product would shrink by 0.2%.

These effects would be felt especially acutely in Minnesota. As McCabe — who is broadly in favor of the scheme — notes:

The relatively low thresholds, paired with a 10 percent phase-out rate, can create marriage and work penalties for many families. For example, a single parent with one child who moves from a minimum to a median wage job would lose their entire $1,000 credit. Similarly, a minimum wage worker with one child would lose almost all of their credit if they married a median wage worker. 

The maximum total credit amount available to families caps at $3,000 per year, penalizing larger families since the credit amount is effectively $0 for any child after the third. 

The credit is layered atop Minnesota’s existing dependent exemption, which also provides support for families with children. This creates two drawbacks. First, families must navigate a complicated maze of overlapping benefits where they may find their child tax credit phasing out as their dependent exemption is phasing in as their income rises. Second, it misses the opportunity to reduce overall costs while making all families better off by consolidating and streamlining benefits.

The current proposal, in short, penalizes both work and marriage. This, coupled with its likely negative impact on the state’s economic growth, should give state policymakers reason to radically rethink this policy.