November 30, 2019 HUMAN RIGHTS

Taxing Poor Kids

by Francine J. Lipman and James E. Williamson
 "If we don't stand up for children, then we don't stand for much." — Marian Wright Edelman

"If we don't stand up for children, then we don't stand for much." — Marian Wright Edelman

Every day in its annual spinning rotation around the sun, the Earth moves from darkness into light. During these 24 hours, more than 1,700 American babies are born into poverty. One newborn is delivered into poverty every single minute of every single day in America. About 900 of these beautiful new lives are born into extreme poverty, struggling to survive on less than $9 a day. In one of the richest countries on Earth, more than 12 million American children live in poverty, including 5 million kids who live in extreme poverty. Poverty statistics are even more deplorable for children of color. Nearly 33 percent of African American children and 25 percent of Latino children live in poverty. Our youngest children, those who are under five years old, whose brains and bodies are still developing, suffer the highest rate of poverty of any age group. While this annual data is profound, the problem is even deeper and broader across their lifetimes. Nearly 40 percent of all children in America spend at least a year in poverty, and more than 10 percent spend at least one-half their childhoods in poverty. Starting at birth, up to and through adulthood, childhood poverty plagues, impairs, limits, and destroys lives.

Poverty costs America almost $700 billion every year as it tears away at bodies, minds, hearts, souls, and communities. Poverty is associated with hunger, homelessness, health, educational hazards, toxic stress, crime, and violence. Food insecurity causes lower reading and math scores, physical and mental health problems, and higher incidence of emotional and behavioral problems. Limited access to healthy, nutritious food can threaten children’s birth weight and physical and mental development and increase the risks of obesity. Infants suffering from poverty demonstrate cognitive deficiencies as early as nine months that often worsen with age. These early disadvantages are hard to overcome even if the cycle of poverty is broken.

Children who experience housing and food insecurity are more likely to suffer chronic health problems and violence. Exposure to financial adversity over a prolonged period can trigger toxic stress that rewires children’s brains, disrupts their social development, and undermines their ability to learn and succeed. Research shows stress increases the likelihood of low educational achievement, unstable employment, adult poverty, and involvement in the criminal justice system. Ninety percent of children who have never experienced poverty graduate from high school, while only 62 percent of children who spend at least one-half their lives in poverty complete high school by age 20. This is not surprising given that these children are more likely to be suspended and expelled for myriad poverty-related issues, including absenteeism and habitual tardiness.

Given the devastating consequences of poverty, individuals who experienced poverty at any point during childhood are more than three times as likely to be poor at age 30 than those who were never poor as children. The longer a child suffers poverty, the greater her risk of becoming a poor adult. A 2017 Urban Institute report found that 80 percent of children who spend at least one-half their childhoods in poverty were neither in school nor consistently working in their 20s. Moreover, the more toxic childhood experiences a person suffers, the greater their likelihood of health problems in adulthood, including heart disease, hypertension, diabetes, substance abuse, and depression.

"There is nothing new about poverty. What is new, however, is that we have the resources to get rid of it." — Reverend Dr. Martin Luther King Jr., 1064 Nobel Peace Prize Award Ceremony

Fortunately, scholars, advocates, and researchers have demonstrated that we can meaningfully mitigate childhood poverty by investing presently available resources in vulnerable kids. Nobel Prize–winning economist Professor James Heckman from the University of Chicago has found that investing in comprehensive quality programs for economically disadvantaged children from birth to age five generates a notably high return on the investment of 13 percent. Programs that provide health care from pre-birth forward and quality early learning produce a significantly higher return on investment per child every year than investing in preschool alone. Heckman has established through decades of research and studies that these programs pay for themselves many times over. Investments in vulnerable children can produce permanent gains in health and well-being, social-emotional skills, and IQ. The increases in parental income of these children after only five years have paid for entire early childhood programs. Heckman, an award-winning expert in the economics of human development, warns that “[t]he cost of inaction is a tragic loss of human and economic potential that we cannot afford.” See www.theheckmanequation.org.

Proposed remedies for poverty often include enhancing existing federal income tax credit provisions, such as the Earned Income Tax Credit (EITC), the Child and Dependent Care Credit, and the Child Tax Credit (CTC). In 2018, refundable tax credits (the EITC and refundable portion of the CTC) lifted almost 9 million Americans out of poverty, including 4.7 million children. Without these tax credits, child poverty would be almost 6.5 percent higher than its already too high rate. The Tax Cut and Jobs Act (TCJA) passed by Congress in December 2017 and rushed into law in 2018 purportedly doubled the CTC from $1,000 to $2,000. However, rather than follow the proven policies laid out by Heckman, Marian Wright Edelman, American Progress, Tax Policy Center, National Women’s Law Center, Center on Budget and Policy Priorities, and countless other experts and child advocates to target investments in vulnerable children, Congress did nothing to invest in our poorest kids, but rather created a windfall for income-rich households. This article describes the failure of the TCJA changes to the CTC.

Under the TCJA, the CTC was increased ostensibly from $1,000 to $2,000 per qualifying child under age 17. However, this statement is deceiving because under the TCJA (and before) the poorest households in America with one or more qualifying children receive a CTC of $0. However, under the TCJA, income-rich households received an increase in their CTC of $2,000 per qualifying child with no cap. How could this be you might be wondering? Well it is because the refundable CTC requires earned income. This article will expose the devil in the details of the CTC before and after the TCJA. Fortunately, the fix is obvious and easy given current tax practices and economic policy.

"Childhood, after all, is the first precious coin that poverty steals from a child." — Anthony Horowitz

How the CTC Works and Doesn't Work

Under the TCJA, the CTC is a federal income tax credit designed as workfare for households with U.S. citizen children. Specifically, for tax years 2018 through and including 2025, the credit is up to $2,000 for each “qualifying child.” For this purpose, a “qualifying child” is a child, grandchild, brother, sister, niece, nephew, or descendant of any of these relatives who is under age 17 as of December 31 of the relevant tax year. A “qualifying child” has to have lived with the taxpayer for more than one-half the taxable year and must have a Social Security number that authorizes work. Prior to the TCJA, a “qualifying child” only had to have a taxpayer identification number. As a result, children who do not have a Social Security number could qualify for the CTC before the TCJA and may qualify after the TCJA changes expire. This change alone has caused taxpaying households with 1 million children to no longer qualify for the CTC.

The CTC is a partially refundable federal income tax credit. What this means is that the CTC reduces a taxpayer’s income tax liability dollar for dollar down to zero and even below zero (generating a cash refund) under certain circumstances, but the refundable portion of the CTC is limited to only $1,400 (indexed for inflation) of the full $2,000. The refundable portion of the credit depends on the amount of the taxpayer’s earned income (e.g., wages, salary, compensation, self-employment income, and tips). Thus, if a household’s earned income is zero, the refundable CTC is zero regardless of the number of qualifying children in the household. Specifically, after the TCJA, a family with one or more children with earned income below $2,500 would not receive any CTC. This was true for the CTC even before the TCJA because the refundable CTC has always depended on earned income. Indeed, the threshold for the refundable CTC was actually $3,000 before the TCJA. As detailed below, this modest last-minute threshold change generates an additional $75 for the entire year for a poverty-level family regardless of the number of children in the household.

A family with earned income above $2,500 will receive a refundable CTC of 15 percent of any earned income in excess of this minimum threshold. Prior to the TCJA, the CTC minimum earned income threshold was $3,000. Therefore, the TCJA increased the CTC by $75 (15 percent of ($3,000–$2,500=$500)) for taxpayers with any number of qualifying children and poverty-level income of $2,500 (or more for up to $9,670). For example, before the TCJA, a household with one or more children and $3,000 of earned income would enjoy a refundable CTC of $0. Under the TCJA, this household would receive a $75 CTC for the tax year. This $75 increase in the refundable CTC under the TCJA is the maximum annual increase for families with one or more children and earned income of up to $9,670.

Families receive a CTC of 15 percent of earned income over $2,500 in 2018 through 2025. Thus, a family with one or more qualifying children in the household and $9,670 would receive a refundable CTC of $1,075 (($9,670–$2,500=$7,170) x 15 percent=$1,075). Before and after the TCJA expires, this household would receive only a $1,000 CTC (($9,670–$3,000=$6,670) x 15 percent=$1,000). In sum, the most vulnerable families with between zero and $2,500 of earned income receive no CTC and families with earned income between $2,500 and $9,670 receive a CTC that is 15 percent of every dollar above $2,500 up to $1,075 (($9,670–$2,500=$7,170) x 15 percent) or $75 more after the TCJA than before. This additional TCJA cash benefit is only $1.44 per week for a household of at least two poverty-level individuals.

As taxpayers have increased earned income, they begin to enjoy a CTC that exceeds the pre-TCJA CTC by more than $75. From $9,671 of earned income up to $11,833 of earned income, the refundable CTC continues to grow by 15 percent of every additional dollar of earned income up to $1,400 (($11,833–$2,500=$9,333) x 15 percent). Thus, for poverty-level households with earned income between $11,833 and $18,350 ($24,400 for a married filing jointly family), the maximum amount of their refundable CTC regardless of the number of qualifying children in their household above one is an extra $400 after the TCJA as compared to before the TCJA. This amounts to an additional TCJA cash benefit of $7.69 per week for a household of at least two poverty-level individuals.

Once earned income exceeds $18,350 for a single parent ($24,400 for a married filing jointly family), then the household begins to have taxable income and thus a federal income tax liability that will be offset with the nonrefundable portion of the CTC. Thus, from $18,351 through $24,351 for single parents with one or more children ($24,401 through $30,400 for married filing jointly families), the refundable CTC will remain at $1,400 and the nonrefundable CTC that offsets federal income tax will increase up to $600 until the taxpayers receive a full CTC tax benefit of $2,000. This amount is a $1,000 higher tax benefit after the TCJA than before the TCJA. Households supporting about 29 million children do not receive the full $2,000 CTC (post TCJA increase of $1,000) because their earned income is too low for the full refundable portion of the CTC or they owe too little in federal income taxes for a full CTC offset.

Before the TCJA, the CTC was targeted to lower- and middle-income households with children. Accordingly, the CTC began to phase out as income increased about $75,000 for single parents ($110,000 for married filing jointly taxpayers). The phase out was gradual, or $50 of a CTC reduction for every $1,000 of adjusted gross income above these income thresholds. Therefore, for a married couple with one qualifying child, their CTC would fully phaseout at $130,000 (($130,000–$110,000=$20,000/$1,000=$20) x $50 or $1,000 reduction of $1,000 CTC). Thus, for income levels at $130,000 and above, households with one child did not receive any CTC benefits. After the TCJA, this dramatically changed and created a windfall for income-rich households.

Under the TCJA, the CTC does not even begin to phase out until household income exceeds $400,000 married filing jointly ($200,000 for single, head of household, or married filing separately). Therefore, married households with one qualifying child and income levels of $130,000 up to $400,000 receive a CTC benefit of $2,000 per child greater than they would have received before the TCJA. Indeed, not until $440,000 of income does a married filing jointly household lose the CTC benefit in its entirety for one qualifying child. If these high-income households have more than one qualifying child, they continue to enjoy $2,000 of CTC for each additional qualifying child even at this high-income level. Thus, these income-rich households receive a windfall TCJA tax benefit of $2,000 per child while lower-income households receive at most a $400 increase. Moreover, under the TCJA, these income-rich households also enjoy reduced marginal income tax rates (15 percent reduced to 12 percent, 25 percent reduced to 22 percent, 28 percent reduced to 24 percent, 33 percent reduced to 24 percent and 32 percent, 35 percent reduced to 32 percent, 39.6 percent reduced to 35 percent and 37 percent (rate income thresholds are not perfectly aligned from pre- to post-TCJA, so these decreases are approximate)) adding to their overall tax cut when lower-income households received little or no marginal tax rate reduction under the TCJA (15 percent reduced to 12 percent and 10 percent before and 10 percent after the TCJA).

"Overcoming poverty is not a gesture of charity. It is an act of justice. It is the protection of a fundamental human right, the right to dignity and a decent life." — Nelson Mandela

Conclusion

In summary, the most vulnerable kids in America who would benefit the most from an investment receive nothing under the TCJA, and high-income households that are less likely to even spend the windfall benefit on their kids or at all receive an uncapped additional $2,000 CTC per qualifying child.

Fortunately, there is an easy fix to this upside-down investment in America’s children, our future. If Congress follows the recommendation of many child and anti-poverty advocacy groups and makes the CTC fully refundable (not dependent on earned income), all households with no-, low-, and middle-income children will receive an investment. This is similar to the Canadian Child Benefit of about $5,600 annually, which is paid to qualifying families in monthly installments. To fund the fully refundable CTC, Congress could reduce the current phaseout thresholds from $400,000 married filing jointly down to $200,000 ($100,000 single, married filing separately, and $150,000 for head of household).

"Children are the living messages we send to a time we will not see." — John F. Kennedy

Congress may also decide to increase the CTC amount to $3,000 for children from birth to five years old given that children in this age group have the highest rate of poverty among any age group. Moreover, children from birth to five are still developing physically. Their brains and bodies are especially vulnerable to toxic stress from poverty and food and housing insecurity. The annual Canadian Child Benefit is higher for children age five and under at $6,600 and is $5,600 for children six through 17 (indexed annually for inflation). Notably, this CTC age-based enhancement is readily audited via taxpayer identification numbers and birth certificates. In short, the TCJA missed an opportunity to mitigate child poverty, reduce rising income inequality, and make an effective targeted investment in America’s future today. Instead, Congress has enacted another windfall for income-rich households that are already enjoying unprecedented wealth and well-being. This is consistent with estimates that more than 70 percent of the tax benefits under the TCJA for 2020, or $205 billion, will accrue to the richest 20 percent of all Americans. In a country where about one out of every six kids suffers poverty, Congress can and should target the CTC to benefit rather than tax our most vulnerable kids.

An expanded version of this article was recently published in Tax Notes Federal, Volume 164, Number 11.

Francine J. Lipman is the William S. Boyd Professor of Law at the William S. Boyd School of Law, University of Nevada, Las Vegas.

James E. Williamson
is an Emeritus Professor of Accounting & Taxation at the Charles W. Lamden School of Accountancy, San Diego State University.