Child care is an essential need for American families, not a luxury. However, the rising costs of quality child care are surpassing other major expenses like housing and higher education, creating a financial strain for many. In 2022, the average annual cost of child care was $10,853, which equates to 10% of the income for a two-parent household and 22% for single-parent families, according to Child Care Aware of America. Even with potential assistance, many families struggle to secure the care they need. The federal Child Care and Development Block Grant (CCDBG), which provides aid to low-income working families, only serves less than 15% of eligible children, putting immense pressure on families’ economic stability.

The U.S. tax code has historically been used to address societal challenges and promote economic growth, such as with tax credits for retirement savings and higher education. Similarly, tax credits should reflect the critical link between child care expenses and parents’ ability to work, given how significant these costs are in family budgets.

Two federal tax credits aim to support families with young children: the Child and Dependent Care Tax Credit (CDCTC) and the Child Tax Credit (CTC). The CDCTC helps working families offset child care costs, while the CTC assists families with general child-rearing expenses. Expanding both credits could significantly enhance the economic stability of families, benefiting children and parents alike.

What is the Child and Dependent Care Tax Credit (CDCTC)?

The CDCTC helps working parents reduce their child care and dependent care costs by providing a tax credit for eligible expenses. It applies to care for children under 13 or adult dependents, with the amount of credit calculated based on the family’s adjusted gross income (AGI).

Families can claim up to $3,000 in expenses for one dependent or $6,000 for two or more. Those with an AGI of $15,000 or less can receive 35% of these expenses as a credit, amounting to a maximum of $1,050 for one dependent or $2,100 for two or more. As income rises, the credit percentage drops to 20% for those earning over $43,000, resulting in a maximum credit of $600 for one dependent or $1,200 for two or more.

Families with lower expenses or employer-sponsored child care benefits may receive a smaller credit. The CDCTC saw temporary improvements in 2021 due to COVID-19 relief, but it has since reverted to its previous levels, unchanged since 2001 and not adjusted for inflation.

What is the Child Tax Credit (CTC)?

The CTC helps parents with children under 17 manage the costs of raising a child. In 2023, the credit was worth $2,000 per qualifying child for those with a modified adjusted gross income (MAGI) below $400,000 (for joint filers) or $200,000 (for others).

While the CTC is nonrefundable, families with a tax liability below the credit’s value may claim the Additional Child Tax Credit, which can provide up to $1,600. The CTC was temporarily increased in 2021 under the American Rescue Plan, raising the credit to $3,000 per child aged 6-17 and $3,600 for children under 6, with full refundability and monthly payments. This expansion helped reduce child poverty to a historic low of 5.2% in 2021.

Why Expand the Child and Dependent Care Tax Credit (CDCTC)?

Since the CDCTC hasn’t been updated in two decades, it hasn’t kept pace with rising child care costs. The current maximum credit only covers about 10% of the annual care cost for two children. Moreover, the nonrefundable nature of the CDCTC limits its benefit for low-income families who often don’t have enough tax liability to take full advantage of the credit.

Making the CDCTC fully refundable, increasing the credit for low-income families, and adjusting it for inflation would provide meaningful support to those who need it most. Data shows that fewer than 1% of families earning under $15,000 claim the CDCTC, while almost 30% of those earning between $100,000 and $200,000 do. Only 12% of taxpayers with children benefit from the CDCTC overall.

Can the CDCTC Be Replaced by Increasing the Child Tax Credit (CTC)?

While the CTC is essential for helping families cover the costs of raising children, the CDCTC plays a unique role in offsetting child care expenses, which are necessary for working parents. Just as businesses deduct costs incurred in earning taxable income, working parents should receive tax relief for child care, an expense tied directly to their ability to earn income. The CDCTC ensures that families can maintain their income while providing access to quality child care, which strengthens the workforce and promotes better early childhood development.

As child care costs rise alongside other household expenses, both the CDCTC and CTC are vital in supporting families’ economic security.