Photo by Anthony Fomin on Unsplash

It seems like a good time to assess refundable tax credits, which provide a benefit regardless of tax liability to assist low income families, given their prominence in the American Rescue Plan to combat the economic impact of Covid-19. The Plan introduced in March of 2021 contained a number of tax credit measures to assist families, especially an increase in the refundable Child Tax Credit from US$2,000 per child to US$3,000 per child for children over the age of six and to US$3,600 for children below the age of six.

The future of the enhanced credit is uncertain as it depends on the Biden Administration’s Build Back Better plan that has been stalled in the Senate by moderate Democrat Joe Manchin. Despite arguments that the Child Tax Credit had reduced children in poverty by 50%, one of Manchin’s central concerns with the Build Back Better plan is that the fully refundable credit provides benefits even if families have no earned income. Manchin opposes the credit in this form and has proposed adding a work requirement going forward.

The history of refundable tax credits in the US

Although it is not clear what type of work requirement might satisfy Senator Manchin, his opposition to a refundable tax credit without work conditions has precedent in the United States.

Following proposals from economist Milton Friedman and other prominent academics for a negative income tax delivered through refundable tax credits, President Richard Nixon proposed a Family Assistance Plan in 1969 to provide US$500 for the first two family members and US$300 for additional family members. It would have a negative tax rate of 50% on earnings, so that workers would retain 50 cents of every dollar earned beyond an exemption of the first US$60 earned per month, and it would be based on average income for the preceding 12 months, a design that could have easily been delivered as a refundable tax credit.

The House of Representatives passed the Plan with bipartisan support but concerns about its work disincentives effects could not be dispelled in the Senate, even with emerging evidence of limited effects from the first income maintenance experiments, and the Plan was eventually defeated in the Senate. In its place emerged an alternative refundable tax credit plan in 1975: a ‘work bonus’ for low-income workers of 10% of earnings to a maximum bonus of US$400 at US$4,000 of earnings with a negative tax of 10% beyond that point to phase out the bonus for those earning more than US$8,000.  This Earned Income Tax Credit has grown in popularity with enhanced benefits, expanded coverage and advanced regular payments through time.

Other refundable tax credits emerged in the US to account for 18% of the roughly US$500 billion in tax incentives, but most were temporary and had expired by 2011. What remains is primarily the Earned Income Tax Credit, the current more modest Child Tax Credit enacted in 1997, and a set of refundable tax credits to subsidise the costs of health insurance which will grow rapidly in value and overtake all other refundable credits as a result of the Affordable Care Act.

The Canadian experience

America’s neighbour has adopted refundable tax credits more enthusiastically. Canada introduced the Guaranteed Income Supplement in 1967 as a refundable tax credit to enhance benefits for seniors, setting the Supplement at 40% of the Old Age Security payment with a negative tax rate of 50%.

A refundable Child Tax Credit was introduced in 1978 to supplement the Family Allowance, a taxable demogrant for each child under 18. The maximum benefit of the new Credit was CA$200 per annum for a family with annual income below CA$18,000 in the previous tax year combined with a negative tax that eliminated the benefit for families with incomes exceeding CA$26,000 per year. The Credit and Family Allowance were replaced in 1992 by a refundable and tax-free Child Tax Benefit of CA$85 for the first two children and CA$91.25 for additional children, indexed to any inflation above 3% per annum, with a negative tax rate of 2.5% for the first child and 5% for additional children on family net incomes over $25,921. The Credit, now known as the Canada Child Benefit, has been significantly expanded to a maximum annual benefit of CA$6,833 per child under age 6 and CA$5,765 per child aged 6 through 17 in 2021 with a complex structure of negative tax rates between 3% and 23% that depend on the number of children, their ages and income.

In 1986, Canada introduced a refundable sales tax credit of CA$50 per adult and CA$25 per child for families and individuals with incomes below CA$15,000 with a negative tax rate of 5% on incomes above CA$15,000 that would restrict the benefit to incomes under CA$18,000. The benefits of the credit, renamed the Goods and Services Tax Credit in 1990, have expanded and are now paid quarterly: CA$456 if you’re single, CA$598 if you have a spouse or common-law partner and CA$157 for each child below 19 that lives with you.

In 1992, a refundable Working Income Supplement was introduced along the lines of the Earned Income Tax Credit in the US. The Supplement provided a credit of 8% of annual family earnings over CA$3750 to a maximum of CA$500, regardless of the number of children, with a negative tax rate of 10% of net family income over CA$20,921 that eliminated the benefit at the same income threshold as the Child Tax Benefit. The benefit, now the Canada Workers Benefit, remains modest in comparison to its US counterpart: CA$1,395 for single individuals with a negative tax rate of 15% for adjusted net income exceeding CA$22,944 and CA$2,403 for families with the same 15% reduction rate for incomes exceeding CA$26,177.

Why refundable tax credits?

The case for greater reliance on refundable tax credits remains compelling. The optimal tax literature has shown that refundable tax credits should be included to direct benefits to those with low taxable incomes under reasonable assumptions. Refundable tax credits are attractive because of their administrative simplicity and progressivity, delivering benefits to families even if they have no tax liabilities, even as issues around the requirements for tax filing and the limitations of annual tax reconciliation remain. As concerns around income inequality, poverty and tax fairness continue to swirl, regardless of the success of the Build Back Better Plan, refundable tax credits provide an attractive and straightforward option for further tax reform in North American and elsewhere.

Leave a comment

Your email address will not be published. Required fields are marked *