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Rich parents get the biggest child care tax breaks

Kids in a US Army day care facility, putting wood blocks into wood things with holes in them for wood blocks.
Kids in a US Army day care facility, putting wood blocks into wood things with holes in them for wood blocks.
Photo courtesy of US Army/Flickr

As any parent can tell you, child care is expensive. Like, really expensive. The median single mother with a child under 5 earns $19,200 a year but spends $3,000 on child care out of pocket. That's 15.6 percent of their income. The share is lower for married mothers and single mothers with older children, but in each case runs in the thousands a year. James Ziliak, an economics professor at the University of Kentucky and director of the university's Center for Poverty Research, points out that in twelve states, child care eats up more than 20 percent of a typical single mother's earnings.

The government's approach now

The federal tax code actually includes a credit to help parents of children 12 and younger afford child care — the Child and Dependent Care Credit — but barely anyone uses it. According to the Tax Policy Center, only 4.5 percent of individuals or couples paying taxes claimed it, and the Joint Committee on Taxation estimates that it will only cost about $3.4 billion this fiscal year; by comparison, the tax code's biggest housing subsidy, the mortgage interest deduction, will cost about $71.7 billion. "To know that that credit is there means that you have a good accountant, or are pretty savvy in terms of your own accounting, because it's not a highly publicized credit," Ziliak says.

But worse than just being small, the credit is very poorly targeted. The Tax Policy Center estimates that families making between $100,000 and $200,000 a year are the credit's biggest beneficiaries. That's not how it's supposed to work; the credit is designed with the intent of being more generous to low income families than high income ones. If you make above $43,000 a year, the credit is worth 20 percent of up to $3,000 (for families with one child) or $6,000 (for families with more than one) in child care expenses. But if you make under $15,000, it's worth 35 percent of those expenses. The problem is that families making that little every year typically have negative income tax liabilities, as refundable credits like the earned income tax credit (EITC) cancel out everything they owe and then some. The child care credit is non-refundable, which means it's only valuable to people who would owe taxes without it. Those people tend to have higher incomes. So while in theory, poor families could get up to $2,100 from the credit, in practice they get nothing:

Tpc_graph_childtaxcredit

Source: Tax Policy Center

The federal government also funds a child care block grant program, the Child Care and Development Fund, to help states provide child care, and states can choose to fund child care out of Temporary Assistance to Needy Families (TANF), or "welfare"; those sources combined to cost about $10.2 billion in fiscal year 2012. Those programs are better targeted (typically they're limited to people making 54 percent of the median income in their state) but they face long waitlists, meaning only one in six eligible kids gets money from them.

The end result is that the typical low-income family gets little to no help from the government on child care. That's a problem when, post-welfare reform, much of the safety net, such as the EITC and TANF, is built on work requirements. "If we want to take seriously aligning the goals of economic self-sufficiency with anti-poverty programs," Ziliak says, "then I think we need to think seriously about child care."

How to fix it

With that in mind, Ziliak and the Hamilton Project have issued a smart proposal for revamping the child care tax credit so it actually helps families most in need. The basic changes he'd make are:

  • Making the credit refundable. Currently, a family making $15,000 that owes no income taxes won't get any help from the child tax credit. Under Ziliak's proposal, they could receive up to $6,000 if they have two or more children under 5 in a licensed child care facility.
  • Phasing out the credit for upper-income people. For people making under $25,000, Ziliak would have the credit pay 100 percent of expenses at licensed facilities, but then gradually reduce that rate going from $25,000 to $75,000, at which point the credit would vanish altogether. This limits the cost of making the credit refundable (Ziliak thinks the proposal could be revenue neutral if not positive overall) while making sure it's targeted most at families that need it.
  • Make the credit more generous for young kids. While children 5 and under in licensed facilities would get 100 percent of their expenses (up to $4,000 for one kid or $6,000 for two) reimbursed, those 5 to 12 would only get 50 percent reimbursed. Either way, that's much more generous than the current credit, but reflects the higher cost of caring for kids who haven't entered school yet.
  • Reward parents who go to licensed facilities. The quality of child care facilities varies widely and really matters to child development. While state licensing standards are far from perfect, this provision encourages parents to go to reputable, center-based providers rather than unlicensed ones where standards for care may be laxer. "To provide high quality child care you have to charge a certain price and only a few people can afford that," Ziliak says. "This credit might drive changes in the market."

Ziliak envisions early childhood education programs, which can have huge effects on childrens' later life outcomes, being eligible for the money too, enabling families who don't have access to Head Start or who want a higher-quality option to put kids in private pre-K programs.

The plan isn't perfect. As Ziliak concedes, the income phaseout effectively places a higher marginal tax rate on poor families, as they have to give up credit money when they start earning more. That's already a huge problem, as the combined effect of taxes and eligibility cutoffs for Medicaid, food stamps, housing aid, and the like can mean poor families face effective tax rates near 100 percent. But the credit would not be a major contributor to the problem compared to those other programs, and short of making child care assistance universal (which would be a good idea but a much bigger lift politically) it's hard to make sure low-income families get aid without some kind of cutoff scheme. Additionally, the proposal doesn't do much to reform the supply side of child care, and it's worth asking how good a test of quality licensing is.

As policy proposals go, Ziliak's is pretty modest, but enabling families with small children to get as much as $6,000 more assistance a year would be a really significant strengthening of the safety net, and make the tax system overall significantly more progressive.

Further reading

  • Edward Zigler, who ran Richard Nixon's efforts to pass a universal child care bill, told me four years ago that making the credit refundable "would be one very reasonable thing to do" but that he didn't "see the will to do this."
  • The Center for American Progress' child care proposal last year is worth looking at if you're interested in less incremental reforms.
  • Jonathan Cohn wrote an incredible piece in the New Republic last year on how poorly regulated the child care market is, centered around a tragic case in Houston where a fire at a home day care killed four children.
  • Alissa Quart had a great explanation of exactly how burdensome child care costs are on families in the New York Times.
  • Jessica Grose points to France as a model child care system; Pascal-Emmanuel Gobry raises some objections.