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Sorry, Expanding the Child Tax Credit is Not the Perfect Conservative Tax ReformTM

Good intentions aside, Sen. Mike Lee’s idea of expanding the child tax credit is far from an ideal supply-side, or even conservative, tax policy.

Over at AEI’s blog, Jim Pethokoukis takes issue with recent criticism from EconLog’s David Henderson that Senator Mike Lee’s new plan to expand the child tax credit from $1000 to $2500 per child is an “anti-supply side tax cut.”  Calling Henderson’s piece a “misguided attack on expanding the child tax credit,” Pethokoukis lists four things that Henderson allegedly “misses” about this part of the Senator’s plan.  Unfortunately, however, it’s Pethokoukis who appears to miss Henderson’s point and a few important others about this proposal and an optimal, pro-growth tax plan.

Before I get to that, however, let’s clarify what Henderson did not say: that Senator Lee’s entire plan, which includes income tax rate cuts and other important non-tax elements, was bad policy.  Instead, Henderson took particular issue with only the part of Lee’s plan which expands the child tax credit.  After running through some basic “supply side” economics (read it there for yourself), Henderson concludes:

…Lee proposes lowering tax rates also. But for a given loss in revenue to the federal government or for a revenue-neutral tax cut, rates could be cut even more without that increase in tax credits. So, relative to a straight cut in marginal tax rates that yield the same revenue as Lee proposes, his tax cut would make the economy smaller.

In other words, the child tax credit expansion would produce relatively less economic growth than a simple cut in marginal tax rates which caused an equivalent reduction in tax revenue.  Put another way: if a child tax credit expansion and a cut to marginal tax rates “cost” the same, the latter will produce more economic growth than the former.

Looking in the wrong place

With this important clarification out of the way, I’ll now run through Pethokoukis’ list of “what Henderson misses” and explain why I think he – and others who believe that expanding child tax credits should be a pillar of any future GOP tax policy – is off the mark.  First, Pethokoukis notes that “[t]he Lee plan would cut tax rates.”  Well, yes, but the quote above clearly shows that Henderson didn’t “miss” that point (and it was even quoted in Pethokoukis’ piece).  Instead, Henderson’s point was that a cut in marginal tax rates would, according to standard supply side mantra, produce more growth than a revenue-matching expansion of the child tax credit.  Thus, Lee’s plan could abandon the child tax credit expansion and cut rates even more, thereby spurring more (and more immediate) economic growth.

Second, Pethokoukis states:

Expanding the child tax credit would help offset two big distortions: a) the impact of payroll taxes on the finances of families who created the taxpayers of tomorrow, and b) the impact of the social safety net on fertility rates. It would also expand the take-home pay of folks who pay payroll taxes but not income taxes.

Maybe this is true but, again, it’s not really Henderson’s point. Expanding the child tax credit is clearly not the easiest or most direct way to eliminate the real (and regressive) distortions caused by the payroll tax, which disproportionately affects middle class American families.  Instead, the obvious way to remedy such distortions is not by expanding child tax credits but instead by – get ready – reducing or eliminating the payroll tax!  Doing so and moving all federal revenue-generation into a streamlined income tax also would produce other benefits, including:

  • It would produce just the growth-juicing cut in marginal rates that, according to Henderson, supply-siders should prefer over tax credits, and it would remove two layers of complexity that burden our current tax code (i.e., the payroll tax and the tax credit).
  • It would be more politically palatable than your typical topline cut to income tax rates.  Because the payroll tax is capped at about $114,000, its elimination would be somewhat progressive – every dollar of the approximately 95 percent of American workers whose salaries are at or below the cap would be freed from the tax, while only the first $114,000 of the remaining five percent would experience a tax gain.  As such, a straight payroll tax cut would mitigate the typical anti-tax-cut demagoguery caused by the cut’s supposedly-disproportionate benefits for “the rich.”  (And these effects could be massaged as needed via the accompanying modification and flattening of income tax rates.)  Of course, the progressive nature of this tax cut would dampen its growth effects for the high-earning “five-percenters”, but it still would provide a more consistent and predictable cut to tax rates for all Americans (especially the other 95 percent) and thus remain preferable to one-off tax credits.
  • Finally, as recently explained by Tim Carney, abolishing the payroll tax would kill the lie that said taxes go into some magical personalized trust fund for Social Security and Medicare: “both entitlements are funded on the margin by general revenues.  So give up the charade and abolish a regressive federal tax.”  Thus, in one fell swoop, elimination of the payroll tax would eliminate anti-family, regressive distortions in the tax code, boost economic growth above that provided by an expanded tax credit, and educate the American public about the true (and precarious!) nature of our current entitlement system.  Not too shabby, huh?

Even if complete abolition of the payroll tax is politically impossible, there are other, similar policies that account for fertility but focus on lowering marginal rates instead of, and due to an aversion to, child tax credits.  Thus, it’s extremely dubious to defend “reform” of the child tax credit on the ground that it indirectly eliminates anti-family biases caused by the payroll tax, given that other reforms can directly attack these biases and are more effective and fruitful.

Third, Pethokoukis defends expanding child tax credits as actually a “supply-side move” because it “might make it easier for [parents] to have as many kids as they desire,” thus boosting fertility and, in turn, helping to finance Medicare and Social Security without raising taxes. This, in turn, would produce a younger, more dynamic society.  However, this rationale raises several red flags.  For one, it again ignores the fact that there are more direct, pro-growth ways to help alleviate American families’ unfair tax burdens, including cuts to parents’ marginal tax rates which would immediately boost economic growth (instead of taking 18 years to foment it!) and/or the elimination of the tax code’s insidious penalties on self-employment or on second-earner spouses who are taxed at their spouse’s much-higher rate.

Moreover, non-tax proposals – including some great ones proposed by Senator Lee, as well as the reform or elimination of dumb government policies which raise food, energy, education and health care prices (again disproportionately hurting large families) or discourage telework – also would more directly and efficiently help parents have and raise kids and otherwise make ends meet.

Fourth and finally, Pethokoukis reiterates the child tax credit’s supply side bona fides by quoting from economist Robert Stein – one of the policy’s first and best advocates – who argues that the policy would increase “human capital” (i.e., kids) because the current entitlement system “implicitly deter[s] people” from raising children as a hedge against old-age poverty.  Most of the points above about other, more direct ways to provide American families with the financial security needed to raise a larger family and retire in relative comfort again apply here.  Using a tax credit to achieve these ends is hardly the most efficient way to do it (especially given how disastrously complicated our tax code already is), and I’m frankly surprised that Pethokoukis and others would so adamantly take this position given the ample economic evidence that tax credits are a pretty distortionary and inefficient means of achieving economic growth or various social policy objectives.

Children as revenue generators

Indeed, Pethokoukis himself admits earlier that the “expanded credit wouldn’t nudge many middle-income parents to have more kids than they desire,” so the tax credit plan is really just a way to goose their budgets.  And, at the risk of sounding like a broken record here, there are plenty of ways to do such goosing without having parents ship their hard-earned money to Washington, only to have it come back once a year in the form of a tax credit (after bureaucratic transaction costs, of course).  Better to keep that money in parents’ pockets in the first place, and let them engage freely in all the babymaking that their little hearts desire, without considering whether it will qualify them for a little extra government cheese.

All of this leads me to one final, broader criticism of any plan to expand the child tax credit as a means of encouraging US fertility rates and thereby supporting entitlements and boosting economic growth: it’s really not very “conservative” at all.  For starters, there is something inherently un-conservative about advocating a policy which views children as future revenue-generators for the State.  Granted, this is only part of Pethokoukis’ and others’ supporting argument, but it’s still a prominent one and, as such, should make any conservative or libertarian more than a little uneasy.  Let’s have kids and promote families because they’re awesome; not because our kids will make a fine future meal for our insatiable Leviathan.

Promoting and expanding a direct tax subsidy for child-rearing would fly in the face of these principles, only with a right-leaning, pro-family gloss.

Furthermore, conservatives (and libertarians) repeatedly and rightly deride liberal policies which promote preferred classes or lifestyles over others and thereby pit citizen groups against each other for a place at Uncle Sam’s feeding trough.  They also constantly preach clarity and consistency in fiscal policy, including a streamlined and simplified US tax code.  Promoting and expanding a direct tax subsidy for child-rearing would fly in the face of these principles, only with a right-leaning, pro-family gloss.  And while such a gloss might be laudable, it’s entirely inconsistent with the classic conservative/libertarian message that the State is too intrusive and unwieldy, and that Uncle Sam shouldn’t be, and isn’t capable of, dictating the intimate details of our daily lives.

Instead, a far more ideologically consistent (and, as noted above, economically efficient) policy would be one which eliminates and streamlines  the tax code to make it easier for all Americans, not just parents, to pursue happiness and live their lives as fully as possible.  As noted above, eliminating the payroll tax is a great place to start, but it’s certainly not the only way forward.  For many people, any such plan would, as Pethokoukis puts it, “make it easier for them to have as many kids as they desire,” but the key word here is “desire” – as in an personal, voluntary, independent choice which needs no government supervision or sponsorship.   As such, any plan which increases parents’ take home pay and lowers the costs of basic necessities could help achieve their (and other Amerians’) desires, so why cling to such an apparently un-conservative way to do it?

By contrast, alternative plans avoid social engineering, maintain a stronger conservative foundation and don’t foment a needless war between “breeders” and “non-breeders.”  This last point is particularly important in an America with extended singlehood and decreasing birthrates.  In such an environment, it seems like political suicide for the Republican Party to further the message that “GOP tax policy is for families only.” By contrast, a broader, pro-prosperity plan – which just so happens to help people have as many rugrats as their Honda Odyssey can hold – avoids such pitfalls and would help restore the Party’s fiscally-conservative, limited government street cred.

None of this is to say that Senator Lee’s plan to expand the child tax credit is horrible policy: in the grand scheme of things, it – along with reductions in marginal tax rates and the overall simplification of our awful tax code – is relatively benign and certainly moving in the “libertarian populist” direction that the GOP desperately needs to go.  It also could be good PR that avoids some of the aforementioned “party of the rich” demagoguery that other Republican tax plans have faced over the years.  And, more broadly, Senator Lee deserves a ton of credit for his creativity and willingness to advance this and other much-needed policy debates.

Great intentions aside, expanding the child tax credit is far from an ideal supply-side, or even conservative, tax policy.  As such, maybe the proposal’s most ardent supporters, not its free-market critics, are the “misguided” ones here.

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The views expressed herein are Scott Lincicome’s alone and do not necessarily represent the views of his employer, White & Case, LLP.

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