States look to child tax credits to boost family budgets

Focus #24 • December 2023


The number of states offering income tax credits to families with children has doubled in the last three years following the expiration of an expanded federal child tax credit in 2021. Wisconsin policymakers thus far have not followed suit, although the state’s tax code does provide some specific relief for parents. Here, we take a closer look at child tax credits as lawmakers debate a range of uses for the state’s record budget surplus.

For years, federal policymakers have debated various forms of expanded child tax credits to reduce poverty and help parents address the high cost of raising children. The federal child tax credit has been expanded twice since 2017 and recently there has been a push to follow suit by some states.

This came during a time of high inflation, rising child care costs, and crucially, as many states enjoyed record budget surpluses. This trend also follows years of declining birth rates and mounting concerns about slow growth and even contraction in the workforce. These same factors are at play in Wisconsin, raising the question of whether an expanded child care tax credit should be on the table as lawmakers continue to debate potential uses for the state’s budget reserves — projected to be more than $4 billion at the close of this two-year budget cycle.

Gov. Tony Evers’ stated priority is to provide funding for the state’s struggling child care industry; legislative leaders seek significant income tax cuts. Evers recently vetoed a bill passed by the Legislature that, in addition to sweeping income tax cuts, would have expanded Wisconsin’s existing income tax credit to offset the cost of child or dependent care.

It is with this Wisconsin backdrop that we undertake a national scan of legislation in other states relating to child tax credits. Along with direct state subsidies for child care and credits or deductions for child care expenses, child tax credits represent a policy lever that state officials can use to help offset the costs of child-rearing for parents and other guardians and perhaps enhance the state’s attractiveness to workers with young families.

Since 2021, some states adopted child tax credits for the first time, while others expanded existing credits by increasing the credit amount or revising eligibility criteria. At least 12 states adopted or expanded the amount of, or eligibility for, child tax credits from 2021 until the present: California, Colorado, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New Mexico, New York, Oregon, Utah, and Vermont (see Figure 1). At least one additional state, Connecticut, adopted a one-time state child tax rebate in 2022.

This approach has enabled policymakers to target tax relief to families with children – an attractive proposition for states that, like Wisconsin, face particularly acute demographic challenges linked to an aging population and declining birth rates. It also comes after the federal child tax credit was expanded in 2021 as part of the American Rescue Plan Act, but then allowed to expire in 2022.

More States adopt credits

Fourteen states had permanent state child tax credits as of the publication of this report, according to the nonpartisan National Conference of State Legislatures (NCSL).

Most states codified a fixed dollar amount for their child tax credits, while a few set them as a percentage of the federal child tax credit. All of the states restrict eligibility for their credits based on the age of the child being claimed, the filer’s household income, or both. Eleven of these states’ child tax credits are refundable, meaning households are eligible to claim them even if they have no income tax liability — in which case they would receive a state payment.

Perhaps the state that has most aggressively embraced the child tax credit is Minnesota. This year, its policymakers enacted a refundable credit that will provide nearly 300,000 households up to $1,750 per child — the largest credit amount of any state, as shown in Table 1. State tax credit amounts vary widely – at the other end of the spectrum is New Mexico, with a credit of between $75 and $175 based on the filer’s income.

Minnesota’s credit also is notable for having the broadest age range of any state for children to qualify for the credit. All other states with child tax credits apply age restrictions for qualifying minor children, with some targeting credits to households with children at young ages, when child care expenses typically are greatest. For instance, Utah limits its credit to children under age four. At the opposite end of the spectrum is Minnesota’s credit, which can be claimed by eligible filers for all children up to age 18.

Minnesota filers are eligible for the full credit amount until their household income reaches the phase-out threshold ($35,000 for joint filers, $29,500 for others). At that point the credit amount is gradually reduced until a filer reaches the income limit, which starts at $52,500 for married filers and $47,000 for other filers. The credit amount increases with each child per household. The state predicts the credit will be a particularly effective tool to combat child poverty, which it could reduce by roughly one-third, according to a Columbia University analysis.

Minnesota this year enjoyed a record budget surplus that, prior to budget approval, was estimated at more than $17 billion. Its new credit comes at a projected cost to the state of more than $400 million per year, various estimates show. This makes it the second-costliest credit of any state, and the costliest on a per capita basis, according to revenue impact estimates compiled by the Institute for Taxation and Economic Policy. Revenue impacts of the credit vary widely among states, from an estimated loss of $780 million annually for New York, to an estimated $9.6 million for Utah.

federal context

The heightened push among states to adopt child tax credits began in 2021 – the same year that the federal child tax credit was temporarily expanded as part of the American Rescue Plan Act (ARPA). The credit previously had been a partially refundable $2,000 per child; ARPA expanded it to a fully refundable amount of $3,600 for each child under age 6 and $3,000 for each child between 6 and 17.

In addition to providing a tax cut for American families, some studies have suggested that the expansion triggered a substantial temporary decline in child poverty. A separate Columbia University study, for example, found it led to a 26% reduction in the share of U.S. children in poverty in July 2021 relative to what it would otherwise have been. The reduction would have been 40% had all eligible households claimed the credit, the study found.

The federal expansion also had a big impact on household budgets throughout Wisconsin. An estimated 599,100 Wisconsin residents received $3.17 billion in federal child tax credits in tax year 2021 as a result of the expanded federal child tax credit, according to the Legislative Fiscal Bureau.

However, the temporary expansion lapsed at the end of 2021 and the federal credit reverted to the previous $2,000 amount and again was only partially refundable. Under current law, the credit falls to $1,000 per child in 2026. This is due to the expiration in 2025 of the federal Tax Cuts and Jobs Act, which doubled the credit following its 2017 enactment.

Other tax breaks for families

While child tax credits are a key mechanism for states to target tax relief to families with children, they are one of several tax credits, exemptions, and deductions that can do so. Other examples already in place in Wisconsin and many other states include the dependent exemption, the earned income tax credit (EITC), and the child and dependent care credit.

Under the current state income tax code, a $700 personal exemption is provided for each individual claimed as a dependent on a filer’s tax return. These personal exemptions are subtracted from the filer’s adjusted gross income to determine their taxable income.

The federal EITC, meanwhile, is a refundable credit based on earned income and family size. Some states complement this with their own EITC. Like most states, Wisconsin’s version is claimed as a percentage of the federal credit. However, it is unusual in that the percentage increases in accordance with the number of children in a household, and that it does not extend to childless households. For tax year 2022, the maximum state credit amount was $149 for single-child households, $678 for two-child households, and $2,358 for households with three or more children.

Since this state credit is targeted toward low-income households, many are not eligible for it. For households with two children, the credit begins to phase out at a household income of $26,260 for joint filers, and completely phases out at a household income of $49,399.

Another federal child tax break is the child and dependent care credit. To claim the credit, filers may claim qualifying care expenses (up to $3,000 annually for one child; up to $6,000 for two or more children, depending on income) for qualifying children under age 13, or for a spouse or dependent not able to care for themselves. Filers may claim between 20% and 35%, depending on income, of eligible expenses for the credit, though the fact that it is non-refundable limits the credit amount for those at lower incomes.

In Wisconsin, policymakers recently revised our state’s counterpart to this credit. Prior to tax year 2022, expenses related to child and dependent care could be deducted from income for state tax purposes, up to $3,000 for one qualifying child and up to $6,000 for more than one child, according to the nonpartisan Legislative Fiscal Bureau.

Beginning in 2022, the deduction was replaced with a nonrefundable credit equal to 50% of the federal credit. The new tax benefit has a larger impact because $1 in credits is worth more than $1 in deductions. Nevertheless, it only makes a small dent in the annual cost of child care.

Another available tax break is dependent care flexible savings accounts, which allow families to pay for up to $5,000 in child care expenses with pre-tax dollars, thereby reducing federal and state tax liabilities. However, a parent’s or guardian’s employer must offer it as a benefit before they can access it.

The increasingly high cost of child care is an issue the Forum has examined in prior reports. The average annual cost of care for a four-year-old in Milwaukee County is $12,142 and for an infant is $16,236, assuming 52 weeks of care, according to data from the state Department of Children and Families’ (DCF) 2022 Child Care Market Rate Survey.

Pros, cons, other options

Our state’s declining birth rate is another key factor underlying the discussion about providing tax relief to families with children. Like other Midwest states, Wisconsin faces strong demographic headwinds, with potentially dire consequences for our state’s economy.

On its own, modest tax relief such as a child credit is very unlikely to change a family’s calculus about family planning, or to incentivize families with young children to move to Wisconsin. However, it could be one piece of a larger strategy to make the state a more attractive place to raise a family.

The potential downsides of any tax cut include the price tag, which — depending on the amount and eligibility criteria — can be formidable. Also, it is important to note that child tax credits are just one of many options at the state’s disposal if policymakers wish to invest resources to address some or all of the issues raised in this report.

For example, the bill Evers vetoed in November would have expanded the state’s existing child and dependent care tax credit from 50% to 100% of its federal counterpart. This general approach would direct more benefits to parents who work, which on the margins might bolster the state’s workforce.

Other leaders may prefer to instead invest directly in the state’s child care providers, given existing gaps in care and the influence that direct subsidies can exert in shaping the overall system. Still others may simply object to the premise of targeting tax relief to families, on the premise that any tax relief should be more broadly distributed.

Regardless, it’s now clear that 2021 was a national inflection point for child tax credits, as more states sought to adopt them. This approach has the benefit of providing relief to all families in a flexible manner that allows them to choose the child care options that best suit their needs. Policymakers in Wisconsin may wish to weigh the pros and cons of this approach as they continue discussion on the best uses for the state’s budget surplus.