June 5, 2003

June 5, 2003 | WebMemo on Taxes

Say No To the "Refundable" Child Tax Credit

Recent media attention has left the impression that H.R. 2 - the new tax bill President Bush signed into law -- does not give a tax cut to many families because of a provision of the child tax credit. Tax cut critics have stepped up their attacks on the law and, ironically, are calling for more tax "cuts."

Usually buried in these stories, if mentioned at all, is that this controversy involves sending larger checks to families who already pay no federal income taxes and receive a check from the government.  These families did not receive an income tax cut, because they did not pay any income tax. Furthermore, most of the media coverage ignores that the President's 2001 tax law benefited many taxpayers in the lower income groups.

Non-taxpayers Get Taxpayer Dollars
In fact, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) offered broad based tax relief only in that it phased in tax relief for most middle and upper income tax filers over the period 2004 through 2010. A list of EGTRRA provisions that took effect prior to 2003 is as follows:

  • Creating the new 10 percent tax bracket, thus effectively dropping the tax rate for low-income taxpayers by 33 percent.
  • Expanding the child tax credit to $600 per child.
  • Expanding the "refundable" portion of the child tax credit to all families with children (prior law made this "refund" available only for families with three or more children).
  • Providing that the "refundable portion of the child tax credit would not count as income for purposes of determining eligibility for federally funded assistance programs.
  • Widening the income brackets for the Earned Income Tax Credit (EITC).

Interestingly, most of the recent clamor has been over the child tax credit. As mentioned above, EGTRRA increased the child tax credit to $600 per child, and expanded the "refundable" portion of the credit to families with less than three children. The amount of this "refund" was set at 10 percent of a filer's "earned income" in excess of $10,000 for the years 2001 through 2004, and, and increased to 15 percent beginning in 2005.

What does all this mean? It means that there is a limit to the amount of the "refundable" child tax credit. To reach this limit, however, tax liability must be zero. An example of this scenario is explained nicely with the following example from the Center on Budget and Policy Priorities:

  • For example, consider a married couple with two children and $20,000 in income in 2003.  Due to the standard deduction and personal exemptions, this family owes no income tax.  Its credit is limited to the amount that can be received in refundable form.  And that amount is limited to 10 percent of earned income above $10,500.  Since the family has $9,500 in income above the $10,500 threshold, it is limited to a refundable child tax credit of $950 in 2003, which works out to $475 per child.  In other words, this family is already unable to use the full $600 per child.  Increasing the maximum credit amount to $1,000 does nothing for this family; its credit still cannot exceed $950 (10 percent of earnings above $10,500), or $475 per child.[1]

Since the new tax law did not accelerate the refundable provision of the child credit, families such as those in the above example will not receive an additional check from the federal government - but they will still pay no federal income taxes and receive a check.

Transfer of Wealth
In response, Senator Charles Grassley (R-Iowa) and Representative Charles Rangel (D-NY), among others, introduced bills to accelerate the expansion of the "refundable" portion of the child tax credit. Despite its name, the refundable portion of the child tax credit is not a refund at all - only those with no tax liability receive the check. We oppose any legislation that increases the so-called refundable portion of the child tax credit.

Good tax policy dictates that people be allowed to keep more of their own money, it has nothing to do with outright transfers of wealth. It is shameful that members of Congress who labeled the actual tax cuts in H.R.2 as "costing too much" now want to provide non-taxpayers with taxpayer dollars. Perhaps these members are against tax cuts because they want to give those tax dollars to people who don't pay taxes?






[1]Andrew Lee and Robert Greenstein, "How The New Tax Law Alters The Child Tax Credit and How Low-income Families Are Affected," The Center on Budget and Policy Priorities, May 28, 2003, at http://www.cbpp.org/5-28-03tax3.htm.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

William W. Beach Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis