The costs associated with quality child care are rapidly outpacing other expenses faced by families, including the cost of higher education. And the economic case for using the tax code to provide relief for families struggling with the cost of child care costs is straightforward, according to Alan D. Viard, resident scholar for federal tax and budget policy at the American Enterprise Institute. “If workers are taxed on their wages, they should receive tax relief for the costs they incur to earn the wages, just as businesses deduct the costs of earning the income on which they pay tax. There can be little doubt that child care costs are tied to work.”
Unfortunately, the only provision in the tax code created specifically to help families with the cost of child care is outdated and is not available to most low-income families. While there are a handful of tax credits and deductions that support families with children, only the Child and Dependent Care Tax Credit (CDCTC) was designed to help working parents with the cost of work-related child care expenses. By expanding the CDCTC and making it refundable, policymakers have an opportunity to help address working families’ child care needs.
The Child and Dependent Care Tax Credit (CDCTC) was created in 1976 to help working parents with work-related child care expenses. Congress approved a temporary increase to the credit in 2001, and in 2012 a bipartisan majority voted to make that expansion permanent.
Today, the credit varies between 20 and 35 percent of qualified expenses up to $3,000 per eligible child. Qualified expenses are capped at $6,000. That means the maximum credit for working parents with two or more children is $2,100, or only about 10 percent of the average annual cost of care for two children in the United States.
Currently, the credit is not refundable. As a result, most low- and some middle-income, tax-paying families with qualified expenses are unable to take advantage of the credit. Therefore, higher-income families benefit most from the tax credit. The Tax Policy Center found that nearly 40 percent of the credit’s value is claimed by families earning $100,000 or more, while almost no families in the bottom income quintile were able to access the credit.
The credit’s expense limits are also not indexed for inflation, so even as child care expenses have risen sharply since 2001, the value of the CDCTC has remained frozen in place.
To help the CDCTC better fulfill its role and help working parents of modest means afford the cost of child care, tax reform should 1) maintain this critical credit amidst efforts by some whose primary goal is to flatten the code, 2) increase the value of the CDCTC sharply, and 3) make the CDCTC refundable, so low- and middle-income families can benefit.
As part of a major overhaul to the tax code in 2017, bipartisan lawmakers were successful in preventing the CDCTC from being eliminated amid efforts to flatten the code. The American Rescue Plan Act, enacted in March 2021, made changes to the CDCTC for tax year 2021 to make the credit fully refundable; increase the maximum credit rate to 50%; increase the phaseout threshold from $15,000 to $125,000; increase the amount of expenses that are eligible for the credit to $8,000 for 1 qualifying individual and $16,000 for 2 or more qualifying individuals (such that the maximum credits are $4,000 and $8,000); and add a phaseout (0-20%) for those with AGI above $400,000, such that taxpayers with income in excess of $500,000 are not eligible for the credit. The Biden Administration’s American Families Plan proposal would make these changes permanent.