The Anti-Poverty, Targeting, and Labor Supply Effects of the Proposed Child Tax Credit Expansion

New Bruce Meyer looks at the likely impact of the child tax credit expansion - he estimates the employment effect of the 1990's EITC expansion would be undone by the CTCT expansion. Basically the CTC work disincentives are significant (which will result in a lower fall in child poverty than proponents ae estimating) core finding, "...The proposed change under the American Families Plan (AFP) to the Tax Cuts and Jobs Act (TCJA) Child Tax Credit (CTC) would increase maximum benefit amounts to $3,000 or $3,600 per child (up from $2,000 per child) and make the full credit available to all low and middle-income families regardless of earnings or income. We estimate the anti-poverty, targeting, and labor supply effects of the expansion by linking survey data with administrative tax and government program data which form part of the Comprehensive Income Dataset (CID). Initially ignoring any behavioral responses, we estimate that the expansion of the CTC would reduce child poverty by 34% and deep child poverty by 39%. The expansion of the CTC would have a larger anti-poverty effect on children than any existing government program, though at a higher cost per child raised above the poverty line than any other means-tested program. Relatedly, the CTC expansion would allocate a smaller share of its total dollars to families at the bottom of the income distribution—as well as families with the lowest levels of long-term income, education, or health—than any existing means-tested program with the exception of housing assistance. We then simulate anti-poverty effects accounting for labor supply responses. By replacing the TCJA CTC (which contained substantial work incentives akin to the EITC) with a universal basic income-type benefit, the CTC expansion reduces the return to working at all by at least $2,000 per child for most workers with children. Relying on elasticity estimates consistent with mainstream simulation models and the academic literature, we estimate that this change in policy would lead 1.5 million workers (constituting 2.6% of all working parents) to exit the labor force. The decline in employment and the consequent earnings loss would mean that child poverty would only fall by 22% and deep child poverty would not fall at all with the CTC expansion...."
Likely employment effects, “…These static calculations ignore any changes in behavior, in particular employment and hours decisions. The AFP CTC would replace the TCJA CTC—which like the EITC has substantial work incentives—with a program akin to a universal basic income that provides benefits regardless of earnings. Consequently, the expansion would reduce the return to work for most working parents by at least $2,000 per child. Among all working parents with earnings below $100,000, the reduced incentive to work at all due to the CTC reform is 88% as large as the reduced incentive to work at all due to a hypothetical elimination of the EITC. We estimate that the CTC expansion would lead 1.5 million working parents to exit the labor force. The vast majority of the effect (1.3 million) is due to the decrease in the return to work.Our estimate is comparable in magnitude to that implied by a National Academy of Sciences simulation of the EITC and to the change in the employment of single mothers during welfare reform. When incorporating the estimated employment reduction into our poverty simulations, we find that the CTC expansion would reduce child poverty by 22% instead of the 34% reduction we found based on our static simulation. The CTC expansion would not decrease deep child poverty, reversing the 39% reduction we estimated based on a static simulation….”

“… Workers with earnings below $50,000 account for 72% of the employment loss (Appendix Figure A8). Most the of the employment reduction (1.32 million) is the result of the substitution effect from a decreased return to work. The remaining portion (0.14 million) is the result of the income effect from increasing incomes of working families. Table 4 reports employment reductions under other labor supply elasticity assumptions. We do not account for the reduction in work hours among current workers who continue working under the CTC expansion. Since the implicit marginal tax rate rises for workers on the phase-in portion of the TCJA CTC, there will likely be a reduction in hours worked among those who continue to work. Whereas the TCJA CTC rewards an additional dollar of earnings with approximately $0.15 of benefits for these workers, the AFP CTC provides no reward for an additional dollar of earnings. We estimate that 10.4 million workers on the phase-in portion of the TCJA CTC face on average a 14.6 percentage point increase in their implicit marginal tax rate due to the CTC expansion (Table 5).30F31 Not accounting for reductions in earnings of these workers facing higher implicit marginal tax rates will lead us to understate poverty in our dynamic simulations. The implicit marginal tax rate also rises for workers on the phase-out portion of the incremental CTC. Because the incremental CTC phases out at a 5% rate, the implicit marginal tax rate of these workers rises by 5 percentage points. However, the hours reductions of these workers are unlikely to lead their families into poverty because the phase-out begins at $112,500 of AGI for head of household tax units and $150,000 for married tax units filing jointly…..”

Here is the sexy stuff, “… The extent to which the decrease in the return to work affects labor supply depends on the baseline return to work. If the baseline return to work is lower, a given decrease in the return to work will reduce labor supply more. Appendix Figure A7 shows the percent decrease in the return to work due to the CTC expansion, relative to the baseline return to work under the TCJA CTC. Workers with earnings between $0 and $30,000 face a mean percent decrease in the return to work between 7% and 10%. The percent decrease in the return to work falls as earnings rise beyond $30,000, reflecting the higher baseline return to work (in dollars) for those with higher earnings. We multiply the percent change in the return to work by the relevant labor supply elasticity for each worker (0.75 for single mother EITC recipients and 0.25 for all other workers with children), and we multiply the percent change in income by the relevant income elasticity (0.085 for single mother EITC recipients and 0.05 for all other workers with children). As a result of the CTC expansion, we estimate that employment falls by 1.46 million workers, representing 2.6% of all working parents...”

“…Of those adults, 23% (13 million) had tax unit earnings of less than $30,000, and 43% had tax unit earnings of between $30,000 and $100,000. For workers with earnings between $30,000 and $100,000, the mean return to work falls by approximately $2,900 to $3,300 (Appendix Figure A6).For workers with earnings below $30,000, the return to work falls by less—with cell means between $450 and $2,400—because their TCJA CTC benefit had not yet fully phased in. Notably, the binned estimates of the decrease in the return to work that we empirically estimate using the CID align closely with the changes in the return to work across current earnings calculated for a hypothetical family in Appendix Figure A1…”

Dynamic Results Accounting for Changes in Labor Supply

"...We start by calculating the percent change in the return to work for each tax unit, which is the change in the return to work due to the CTC expansion divided by the current return to work under the TCJA CTC. The change in the return to work is the incremental CTC benefit when working at the current earnings level minus the incremental CTC benefit when not working (as described in Section 2). The current return to work under the TCJA CTC is current earnings minus the additional tax liability accrued due to working minus the transfer benefits lost due to working. To calculate the percent change in the probability of working for each tax unit that is currently working, we multiply the percent change in the tax unit’s return to work by the relevant elasticity for the tax unit. We apply an elasticity of 0.75 for single mother tax units currently receiving the EITC and 0.25 for all other tax units. The 0.75 elasticity for single mother tax units receiving the EITC is equal to the midpoint of the 0.3 to 1.2 range recommended for EITC-eligible workers based on the literature review relied on by the CBO (McClelland and Mok 2012).26F27 The 0.25 elasticity is consistent with those used by other simulation models and the academic literature (Congressional Budget Office 2012; Chetty et al. 2013).27F28 As we show later, our elasticity assumptions produce employment effects consistent with the NAS (2019) simulation of an expansion of the EITC. In addition to the effects of a decreased return to work, the increase in incomes due to the CTC expansion would be expected to further reduce labor force participation through an income effect. To estimate the reduction in labor force participation due to higher incomes, we apply elasticities that indicate the percent change in the probability of participation due to a one percent change in income. We follow NAS (2019) in their simulation of a child allowance, which uses an elasticity of -0.085 for single-mother tax units. We assign an elasticity of -0.05 for all other tax units.28F29 We multiply these elasticities by the increase in income due to the CTC expansion divided by income under the TCJA CTC for the tax unit’s family. To estimate the total number of current workers exiting the labor force due to the CTC expansion, we multiply each individual worker’s weight in the CPS ASEC by the percent change in the probability of the worker exiting the labor force, either due to the decrease in the return to work or to higher incomes. We sum these products over all workers with children in the CPS ASEC to estimate the number of current workers exiting the labor force. See Appendix C for further details of our methodology. We report changes in work incentives and employment for workers based on the earnings of their tax unit, in intervals of $10,000. We estimate that there were 56 million adults with children who worked during the year and were a member of a tax unit with nonzero earnings (Appendix Figure A5)…”

How they get there.