What If Congress Made The Child Tax Credit Taxable?

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as my colleague Elaine Mag noted the other dayDemocrats are feuding again (or it still is) over how to structure child tax credit, Some want to ensure that very low-income families get full credit. Others want to reduce or eliminate benefits for high-income families.

Many solutions to the problem of high incomes are either put off for political reasons or, as Elaine noted, create a mess of unintended consequences. So here’s another idea: Make the credit taxable.

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Currently, up to $400,000 in full credit is available for parents. Elaine suggests an easy way to offset this: raise the top personal income tax rate. But Democrats dropped that idea when Senator Kirsten Cinema (D-AZ) said she would not vote for any version of President Biden’s Build Back Better (BBB) ​​plan that includes raising rates.

If Congress makes the credit taxable, it will still be tax-free for families whose income is less than the standard deduction ($25,100 for couples filing jointly in 2022). But the after-tax value of the credit will gradually decrease as income increases for all other parents.

It would be unusual to make CTC taxable. The government would be giving money with one hand and withdrawing it with the other.

But it won’t be unheard of. After all, it already happens social security benefits Where joint filers with incomes of at least $32,000 and single filers earning $24,000 or more are required to pay personal income tax on part of their Social Security benefits.

Payments to Alaska residents from the state’s Permanent Fund Dividend Program are subject to federal income tax. In New York, the Tax Court ruled in 2015 that the refundable portion of the New York State Business Tax Credit must be treated as taxable income, According to an article in the Journal of Accountancy,

Similarly, some versions of a universal basic income make those payments taxable. My colleague Len Berman has proposed a Universal Earned Income Tax Credit That too would be taxable.

So far, Congress has attempted to target the credit by phasing it out at certain income levels—starting at $150,000 for the now-expired provisions in the American Rescue Plan and the version included in the 2017 Tax Cuts and Jobs Act (TCJA). for $400,000.

But, as Elaine pointed out, step-outs are clumsy and especially problematic at lower income levels. Eliminating credits creates several problems: It results in higher marginal tax rates through a phased out limit. It is difficult for tax filers to understand. And it makes the CTC feel like a welfare program, which could make it more politically unstable than it used to be.

Taxing child credit is not the norm. This would set a precedent for refundable tax credits that could haunt many advocates for government assistance programs. Plus, it will cut taxes for high-income families with children.

Congress can address that problem by combining the tax with a higher-income phase-out. In other words, taxable Credits can expire at between $200,000 and $300,000 (or wherever Congress chooses). But parents with higher income will be ineligible for Any Credit.

Or, to protect some middle-income parents, only benefits above certain amounts will be taxed. It would be similar to how Social Security functions today, although it could be made less complex, Of course, any of these adjustments would make the program more complicated, partially defeating one of the benefits of the taxable credit.

Lawmakers may want to separate the credit as income for tax purposes from the income used to determine eligibility for other government assistance, such as Medicaid.

Still, a taxable credit may cost less and be easier to administer than the tax-exempt version with many phase-outs, which is the goal of most congressional Democrats. This can satisfy cinema as it is not an increase in the tax rate. This may be acceptable to Sen. Joe Manchin (D-WV), who opposes giving benefits to high-income families, although it would not satisfy his other demand: for a job in need.

There are other ways to pay for the extended CTC without increasing the tax rates. For example, Congress could eliminate tax priorities that largely benefit high-income households. Sen. Mitt Romney (R-UT) will partially fund his family protection act, a replacement for the CTC, by eliminating the state and local tax (SALT) deduction. But downplaying popular preferences is not in the political cards either.

Given the limited options Democrats have struggled to pass Build Back Better in some form, they may want to think more creatively about how to restore the more liberal CTC that ended last month, while those Support should be better targeted to those who need it most. And tax benefits are one way to do that.

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