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In the American Rescue Plan (ARP) approved in March 2021, President Biden extended and radically modified the Child Tax Credit (CTC) for one year. As part of the proposed reconciliation package, policymakers are now debating on the expansion’s future. Still, a wide range of estimates for the impacts of a permanent development is confounding the argument.
The American Recovery and Reinvestment Act (ARP) increased the maximum Child Tax Credit (CTC) amount, raised the qualifying child’s age and cut the incentive to work. It also removed the participation bonus, making the full amount of the credit available to lower-income households.
The various ways in which modifying the CTC could affect employment decisions are frequently mixed up. Clarifying the distinctions between income and substitution impacts can help explain why analyses suggest that recipients will lose jobs if the extended CTC persists. According to research, substitution effects outnumber income impacts.
For example, the Congressional Budget Office (CBO) employs a central estimate of -0.05 for income effects and a range of 0.15 to 0.35 for substitution effects when calculating the responsiveness (or “elasticity”) of labour supply to a change in after-tax income (for primary earners and varies with income level). The substitution effect would lower labour supply by 0.70 per cent, while the income effect would raise labour supply by 0.13 per cent, for a net loss of 0.57 per cent with a 2 percentage point increase in tax rates on all income.
What about the enlarged Child Tax Credit’s other consequences?
According to the Center on Poverty & Social Policy, a $1,000 increase in home income might result in a $1.129 rise in children’s future wages. Another analysis compares the EITC to the CTC and concludes that the benefit is much lower.
Another disadvantage is that such analyses do not necessarily provide a clear picture of the costs and benefits of the enlarged CTC since they typically leave out the substitution effects outlined above and the taxes that would be needed to fund the expanded CTC in the long run.
As lawmakers consider whether to reintroduce a participation incentive to the expanded child tax credit or make other structural changes in reconciliation, they should consider how the CTC can influence labour supply decisions and the implications for the credit’s poverty-reduction impact.
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