Electoral Issue #1: Investing in the Future – Child Tax Credit

Supporting investment in children is a key election issue in the US. Economic research shows us what its impacts will be.

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With the US presidential elections coming up in November, several issues have come to the forefront. Over the next couple of months, we will focus on what economic research has to say about these issues. We will not be focusing or assessing specific policy proposals, but rather what the economic literature can contribute to our understanding of the issues. Although the inspiration for these articles is the US election, these issues are broad enough to impact many countries.

Today, we will cover government support offered to families with children. In the US, the main government support mechanism has been the child tax credit. Economic research tells us why this has been an effective method of assisting families with children and that this form of support is a net-positive investment for society. Let’s dive in.

Background on the Child Tax Credit

The original US Child Tax Credit (“CTC”) was a program introduced in 1997 that intended to improve outcomes for families with children by offering a tax credit when filing taxes (i.e. all tax filers with children, regardless of income level, could reduce their tax obligation by deducting $500 per child off their tax bill). Because this was a tax credit, families could only directly benefit from this program if they had a tax obligation. If you were not making any income, you would not owe any tax in the first place, so there was no benefit from reducing your tax obligation. 

In 2017, under the Tax Cuts and Jobs Act, the tax credit was increased to $2,000 per child and eligibility criteria were reduced for the CTC, including expanding the credit to a majority of no income families (i.e. they were transferred money even if their owed tax was $0). In 2021, under the American Rescue Plan Act, the program was further expanded, including an increased annual credit from $2000 to $3600 per child and removal of all income eligibility restrictions, making all low and no income families eligible to receive the full amount of the CTC regardless of their tax obligation. Essentially, the CTC was no longer a credit on your tax obligation but rather a cash transfer for all tax filers with children. 

However, this last program expansion in 2021 was not permanent as it expired at the end of 2022 (the 2017 expansion is scheduled to expire in 2025). The 2021 expansion was not renewed as part of the 2023 budget and many low to no income families have lost their CTC benefits. 

The expansion of the program in 2021 has served as an important natural experiment¹, with many new studies talking about the impact of the CTC. 

The CTC and Child Development

The CTC is a program that increases the incomes of impacted families. In order to establish what impact the program had, we are interested in looking at how children's outcomes, such as educational attainment, income in adulthood and malnutrition change due to the increased incomes. As is typical in such situations, establishing causation is not straightforward, as there can be many other factors that may be influencing outcomes (for example, wealthier parents may have attained higher educational degrees, which impacts how they raise their child – in this case, the causal impact would be the parents having a higher degree rather than higher income). 

Before delving into the specific impacts of increased cash transfers to families, it is important to discuss through what potential channels children are impacted in their development. Wimer and Wolf (2020) summarize the research on child development by emphasizing two channels: 

• family stress; and

• family resources (or investment).

Family Stress

Family stress focuses on “the economic hardship that comes along with low income and poverty”. These hardships generate numerous negative consequences such as worse mental health and impaired family functioning. There are also direct health impacts on babies due to maternal stress. Higher levels of maternal stress hormones have been shown to correlate with their children’s IQ and educational attainment. Family stress also impacts the bonding process between children and parents, and impacts behavior outcomes of children as well.

Family Resources

The family resources channel focuses on the investment into children in the form of financial investment (learning materials, toys, extra-curricular activities) and time investment (parents spending time with their children). The impact of family resources has been documented and demonstrated to have a proven positive impact on children’s outcomes. However, this does not necessarily demonstrate that only increasing income will have a positive effect, as the additional income may or may not be spent toward child investment. 

Wimer and Wolf summarized that income has been found to matter in three key ways:

1. The depth of poverty matters – the scarcer the resources, the more detrimental it is for children’s development. 

2. The duration of poverty – the longer the child lives without the necessary resources, the worse the developmental outcome. 

3. The timing of poverty is important – income is significantly more important in early childhood, between the ages 0 and 5, than it is in older childhood or adolescence. It is very difficult, if not impossible, to catch up with any development deficiencies that occurred in early childhood, regardless of subsequent investments made.

Establishing the Impact of Additional Cash Support

Bastian and Michelmore (2018) used changes in a program that is similar to the CTC, the Earned Income Tax Credit (“EITC”)², over the last 40 years to determine the impact of additional income on children’s outcomes. They found that for 13-18 year olds, an extra $1,000 in EITC given to their families increases the likelihood of completing high school by 1.3%, completing college by 4.2%, being employed as a young adult by 1.0% and earning higher wages by 2.2%. Additionally, Manoli and Turner (2018) showed that $1,000 of EITC increased college enrollment among low income families by 0.5 percentage points. Regarding short term benefits, the EITC has been shown to also reduce incidence of low birth weight – for every additional $1,000 in EITC, low birth weights fell by 2-3% (Hoynes, Miller and Simon, 2015). It has also resulted in an increase in children’s test scores (Dahl and Lochner, 2012). 

Recent research by Ananat et al. (2021), specifically on the CTC, has shown that the expanded CTC reduced food insufficiency by 7.5 percentage points (25% reduction). The effect was most concentrated on families with annual incomes less $35,000. Furthermore, CTC payments reduced child maltreatment reports (Kovski et al., 2022).

Evidence on CTC Spending

Besides looking at aggregate outcomes, we can also look at how the expanded CTC benefit was spent by the families that received it. Schild et al (2023) used the Consumption Expenditure (“CE”) survey data collected by the Bureau of Labor Statistics (BLS). The CE survey, which is used for measuring inflation, is an in-depth interview with selected households going over their households’ expenditures. Additionally, the BLS conducts a diary-survey, during which selected households maintain a detailed expenditure ‘diary’ over a course of several months. 

Schild et al. found that for $100 every in CTC benefit, households on average spent:

• $28 on food;

• $31 on housing³; and 

• $15 on child related goods and service.

Parolin et al. (2024) looked at the same question, but using a different methodology. Rather than relying on self-reported data, Parolin et al. used anonymized mobile geo-location data along with debit/credit card data to investigate people’s responses to an increase in the CTC. Parolin et al. found that on average, a $1000 CTC transfer increases child-care center visits by 6.7%.

Moreover, a $1000 CTC transfer increased spending at restaurants by 3.1%, at grocery stores by 3.3% and at personal care establishments⁴ by 3.6%. Interestingly, whether the CTC was paid out on a monthly basis or in a lump-sum mattered, even though the amount was the same. Recipients of the monthly payment spent more on food, while lump-sum recipients spent more on ‘durable’ items such as children’s clothing.

Overall, evidence shows that the recipients of the expanded CTC spent the benefit predominantly on items that directly or indirectly benefit children.

CTC Drawbacks?

The CTC has been shown to have a significant amount of positive effects on spending on children and child development, which translates into long-run benefits such as higher educational attainment and higher incomes. However, evaluating policies requires taking into account the Lucas Critique. When a new policy is introduced, individuals impacted by this policy might alter their behavior. Regarding the CTC, as families may now receive unconditional extra income, they may choose to reduce the amount of labor they supply, reducing their income. Thus, the net impact of the CTC might not be equivalent to the CTC amount.⁵

Focusing on the recent CTC expansion, Ananat et al. (2022) find no discernible impact of CTC on labor supply decisions either on the intensive margin (number of hours worked) or the extensive margin (the decision to look for a job)⁶, implying that parents do not work less when receiving this benefit. However, due to the recent and temporary nature of the CTC program, the result might not hold true if this benefit were made permanent. Other studies that looked either at natural experiments (Akee et al., 2010) or the EITC (Nichols and Rothstein, 2015) find varied (certain people increase work, others decrease work)⁷ but small impacts on labor supply decisions.

Overall, in economic research, there is evidence that higher income does reduce supplied labor (i.e. the more one earns, the fewer hours they want to work). This relationship is frequently used in economic modeling (Blundell and Macurdy, 1999); however, it appears this effect is far more muted or non-existent when looking at low income families. 

The CTC, as mentioned above, could potentially impact the family stress component by improving parents' mental health. Glasner et al. (2022) looked at the impact of the recent CTC expansion and found no significant change on the perceived well-being or mental health of parents. Although this result is surprising, especially in lieu of research that has found that the EITC does have positive impacts on mental health, the authors speculate that this could be due to the temporary nature of the expansion of the CTC program. 

Estimating the Net Impact of the CTC

The above discussion focused predominantly on the impact of the CTC on the direct recipients of this benefit. When evaluating the policy economy and society wide, it is important to assess the total impact on all participants in the economy, which naturally includes the tax cost of this program.

In a recent study, Goldin, Maag and Michelmore (2022) estimate the direct budget impacts of the expanded 2021 CTC. The additional cost of the expanded CTC (i.e. the incremental additional cost to the 2017 CTC) is estimated to be approximately $25.5bln annually. To be conservative, the authors also assume that families would reduce labor supply in response to the CTC benefit, which would reduce tax revenues by $0.7bln. Since children in the families impacted by the CTC benefit would have overall better educational and employment outcomes, their future income and therefore, future taxes would increase. As this is a benefit in the future, it needs to be discounted. The increased tax revenues from the children’s higher incomes would be expected to be larger by $5bln in present value terms. This would put the fiscal cost of the program at $21.2bln. 

However, this estimate does not take into account many of the other societal costs that can impact the budget. Focusing only on the direct fiscal impact of the CTC is insufficient in estimating the true costs and benefits of the program. The CTC reduces many other future costs – it reduces the need for government health expenditures on both parents and children, reduces food assistance costs, reduces crime costs, increases the children’s life expectancy among other things. 

Garfinkel et al (2022) estimate the impact of the CTC (or any cash transfer program that impacts families) by factoring into account many of the additional effects (some of which were mentioned above) that have been estimated in economics research. The authors find that the total cost of the 2021 CTC is approximately $97bln (not incremental), but the overall societal benefits are at $929bln. In terms of breaking out the impact, the table below presents the estimated changes of the 2021 CTC by looking how a $1,000 CTC transfer would impact the different budgetary considerations.

The vast majority of the life-time benefit goes to the direct beneficiaries – the recipients of the benefit. However, for the indirect taxpayer (the taxpayers that do not receive the benefit), the program is also net positive. The main positive impact for indirect taxpayers is a significant reduction in the expenditure related to crime. This is one of the largest impacts of many cash transfers that is not easily noticeable – the absence of crime is not something that is tangible. Thus, very often this positive impact is not taken into account either by individuals or policy makers, although individuals would be willing to pay a large amount to avoid being victims of crime.

Conclusion

The CTC, especially in its expanded 2021 form, appears to have had significant benefits to both the direct recipients and the wider society. Direct beneficiaries see a very large positive impact from the program with better health, higher educational attainment, improved longevity, and better mental health. Indirect taxpayers also benefit from this transfer, primarily through crime reduction, but also through increased future tax revenues and reduced costs of other public assistance programs. These benefits for indirect taxpayers, however, take time to realize and the benefits only accrue if the program is in place for a prolonged period of time. As policy, the CTC is akin to an investment in human capital, as it reduces child poverty, hunger and housing insecurity. Economic research has shown that this form of investment has significant payoffs to society, potentially up to 10 times its cost.

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Interesting Reads from the Week

1. Article:

   Unraveling Economics
   tackles the recent heated discussion around ‘price gouging’ and an opinion piece about ignoring economists. Good read to separate some of the fact from fiction.

2. News: The US Department of Justice sued a company, RealPage, for aiding in price fixing house rents. RealPage claims it allows landlords to outperform competitors by 2% to 7%. To put into context, upzoning a city (Sao Paulo study) by 36% (i.e. allowing the city to be 1/3 denser), reduces house prices by about 0.5%.

3. Note: Jerome Powell recently talked quite a bit about inflation expectations. Here is our quick take on why inflation expectations matter:

1. In the hard-sciences (e.g. biology, chemistry), an experiment is when we take two groups and treat one of them with an intervention (for example, a medicine) and argue that any difference of outcomes between the groups is due to the treatment. That is because there shouldn’t be any difference in the group prior to the treatment if the enrollment into the groups was random. In social sciences (e.g. economics, psychology), such experiments are usually not allowed for ethical reasons or feasibility. However, they tend to occur naturally due to laws and regulations that arbitrarily divide people into two groups. For example, two groups with no discernible difference between them: one that receives government intervention and one that doesn’t.

2. The EITC program, introduced in 1975, offered low income tax filers a direct cash transfer. The amount offered in 2022 ranged from $560 to $7000 depending on family status. Researchers were able to use the fact that some people who were eligible for the program applied for the EITC, while others didn’t, even though they were eligible. Comparing these two groups of people – the ones that claimed EITC and the ones that didn’t – allows us to estimate the causal impact of additional EITC cash on a variety of variables.

3. Housing costs include: shelter cost; utility cost; household operations; house furnishings and equipment. It does not include mortgage payments.

4. Personal care establishments are defined as doctors’ offices, dentists’ offices, family planning services; pharmacies, cosmetics stores, other health and personal care stores and barber shops.

5. A family receiving $1,000 CTC might now work less, reducing their income and the overall net effect would be $1,000 plus any change (reduction) in income.

6. The intensive margin is how much you do of a certain action and the extensive margin is the decision whether to do a certain action.

7. The reason parents might work more when receiving an unconditional benefit could be because they are able to afford child-care and therefore, have a permanent job.