Means-testing the Child Tax Credit

Matt Yglesias has published an interesting essay at his substack by Simon Bazelon and David Shor arguing that Democrats should introduce stricter means testing into the Child Tax Credit. Their key points are as follows:

• The current CTC design already has means-testing for very high incomes, which means that the administrative burdens associated with means-testing (making low-income people file tax returns, etc.) are already being incurred.
• Means-testing will lower the cost of the program and allow Democrats to make it permanent now, rather than letting it expire to reduce its budgetary cost and creating a serious risk that Republicans will block an extension.
• Means-testing increases the political popularity of the program substantially.

I would add two points.  First, Senator Manchin has expressed support for limiting CTC eligibility to lower-income families and adding work requirements, so stricter means-testing without work requirements might be a workable compromise between Manchin and progressives.  Second, means-testing not only creates administrative burdens, it also creates a risk that families will face benefit clawbacks at the end of the year if they underestimate their income. This can happen because the new credit is paid out monthly, during the tax year that will determine eligibility, rather than being a refund paid a year in arrears when people file their taxes (like the EITC).

Here I want to outline two simple ideas for making means-testing work.

First, the government should fill out income tax returns for all filers using the information that has been reported to the IRS.  This is a good idea in general, but Congress has repeatedly caved in to pressure from tax-prep firms and refused to implement.  Because giving people pre-filled income tax returns would make it much easier for low-income people to file their taxes, it is a critical component of means-tested benefit programs.  

Second, to avoid the clawback problem, the credit amount that parents get for the year starting in (say) June of 2022 could be based on their taxable income in calendar year 2021. If their income goes up in 2022, they would get a bit of a windfall – a higher credit than they would otherwise be entitled to. This would be a kind of reward for getting a raise or working more hours and shouldn’t be controversial (an exception might be made for people who have low incomes due to enrollment in graduate schools that typically lead to high incomes, but the complexity might not be worth it).

The potential for problems arises when someone has a drop in income during 2022.  If the CTC amount is based on 2021 income, it will not adjust upwards if income falls in 2022.  This is not necessarily a big problem if the drop in income is small.  But if the income drop is large, we would want parents to get a larger credit to help protect their children from poverty.

The way to deal with this is to let parents apply to get a credit based on their current income.  In this case, the program would work as it does today.  There would be a need to make a filing of some sort based on an estimate of current income, and there would be a risk of clawback or recapture at the end of the year. But the number of families that would need to do this would be relatively small, and the (hopefully not too large) hassle of filing and the risk of a clawback would discourage people from filing when they experience small income drops.