Let’s Put an Income Floor Under Each Child, but Let’s Not Overclaim

Eduardo Porter writes in the New York Times about an intriguing anti-poverty proposal promoted by the Russell Sage Foundation:

Why not get rid of the child tax credit and the child deduction entirely, and instead provide a monthly check of $250 for every child in the country, to guarantee a minimum level of well-being? . . . According to the [Russell Sage] researchers, it would cut child poverty by over 40 percent and deep poverty by half. . . . Best of all, a universal program would avoid the bad incentives of targeted credits, which discourage work because they are phased out as parents’ earnings rise.

I think this is a fantastic idea. It would not, however, “avoid the bad incentives of targeted credits.” It would instead raise marginal and effective tax rates for millions of families (and not by an insignificant amount).

Consider a family of two adults and two children with adjusted gross income of $100,000 a year, filing jointly and claiming the standard deduction ($12,600). Under current law, this family would be able to claim deductions of $4,050 for each adult and each child, and so (if I’m doing the math right — please let me know if I’m not) would have taxable income of $71,200, putting them in the 15% tax bracket. Their total federal tax (10% on the first $18,550 plus 15% after that) would be $9,752.50; they would receive $2,000 through the child tax credit; and their after-tax income would be $92,247.50 (i.e., $100,000 — $9,752.50 + $2,000).

Now consider the same family under the Russell Sage plan. No longer able to claim a $4,050 deduction for each child, their taxable income rises to $79,300, putting them in the 25% tax bracket. Their total federal tax rises to $11,367.50. Now they receive $250 for each child each month — $6,000 a year in total — but no child tax credit. Their after-tax income is now $94,632.50 (i.e., $100,000 — $11,367.50 + $6,000). In this respect, they are winners under the Russell Sage plan.

But note two important changes. First, the family’s marginal income tax rate has risen by 10 percentage points. Second, their effective rate rises by 3.62 percentage points. (To see why, consider the fact that under current law the family’s after-tax income divided by their pre-tax income is 92.25%. Under the Russell Sage plan, their after-tax income, minus the $6,000 they receive regardless of whether they work, divided by their pre-tax income is 88.63%; and 92.25% minus 88.63% equals 3.62%.) If we think that marginal and/or effective rates matter for work incentives, we might be worried about this result.

Now consider a second family of two adults and two children with adjusted gross income one-fourth as high: $25,000 a year. Under current law this family would have no taxable income (i.e., they would fall in the 0% bracket), and they would receive an earned income tax credit of $4,138 plus a child tax credit of $2,000; and so their after-tax income would be $31,138. (Their marginal rate would actually be positive 21.06% because they fall into the earned income tax credit phaseout range.) Under the Russell Sage plan, their taxable income rises to $4,300, putting them in the 10% tax bracket and leading them to owe $430 in income taxes. Their after-tax income (including the EITC and the $250 per month per child) is now $34,708, again making them winners. But their marginal rate rises by 10 percentage points and their effective rate rises by 9.72 percentage points. (To see why, consider the fact that under current law the family’s after-tax income divided by their pre-tax income is 124.55%. Under the Russell Sage Plan, their after-tax income, minus the $6,000 they receive regardless of whether they work, divided by their pre-tax income is 114.83%; and 124.55% minus 114.83% is 9.72%.) Again, if we think that marginal and/or effective rates matter for work incentives, we might have cause for concern.

What’s driving these numbers? First, eliminating the existing deduction of $4,050 per child pushes many families into a higher tax bracket. Second, receipt of the child tax credit is contingent upon having income; receipt of the $250 per child per month check under the Russell Sage plan is not. That is, I think, one of the virtues of the Russell Sage proposal. But it does reduce the reward for working. And this is even before taking into account the rate hikes that would be required to raise an additional $90 billion a year, which Porter reports is the net price tag of the plan. Dividing $90 billion by the $3.557 trillion in modified taxable income reported in 2014 gives us a rough estimate of what that rate hike might look like: approximately 2.5 percentage points across the income tax schedule.

There are, to be sure, two ways in which the Russell Sage plan would increase work incentives. First, for married-filing-jointly taxpayers with modified adjusted gross income above $110,000, the existing child tax credit phases out, which effectively adds 5 percentage points to the marginal rate of filers in the phaseout range ($110,000 to $150,000 for a married couple with two children). Second, for married-filing-jointly taxpayers with adjusted gross income between $311,300 and $433,800, the personal exemption phaseout adds slightly more than 1 percentage point per child to the marginal rate. (These dollar thresholds are lower for taxpayers who are unmarried or who file separately.) If the Russell Sage plan eliminates the child tax credit and disallows the $4,050 deduction with respect to children, then it would eliminate the marginal-rate effect of these phaseouts too. (But remember that these marginal rate reductions would be offset by the rate hike necessary to raise an additional $90 billion.)

So in sum, replacing the child tax credit and the $4,050-per-child deduction with a check of $250 per child per month would raise marginal rates for many lower- and middle-income families, would raise effective rates even for lower- and middle-income families that aren’t bumped up a bracket, and might lower marginal (but not effective) rates for higher-income families in the child tax credit and personal exemption phaseout ranges. I’m not claiming that these would lead to first-order effects on labor supply. What I am saying is that when you eliminate deductions, you push some taxpayers into higher brackets, which in turn discourages work. And when you eliminate tax credits tied to income, you also reduce incentives for labor market participation. And so too if you raise rates across the board in order to generate an additional $90 billion. None of these are reasons not to pursue the Russell Sage proposal. But let’s not oversell the benefits of universality.