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- While states are plagued with budgetary imbalances, reductions in individual income tax credits are being considered.
- The casualties of income tax credits include the credits that many states offer for child and dependent care costs.
- Taxing luxuries at higher rates than necessities reduces inequality but increases work disincentives.
- The most common form of child care tax relief is a tax credit linked to the federal child care credit.
- In general, the federal credit fails to offer adequate relief for child care costs.
As governors and state legislators across the country search for ways to address the budgetary imbalances that many of their states face following the Great Recession, reductions in individual income tax credits and deductions are being considered. Unfortunately, the casualties of that process may include the tax credits or deductions that many states offer for child and dependent care costs. Because those provisions offer tax relief for costs of earning taxable income and thereby promote economic efficiency, we recommend that state lawmakers leave them unimpaired.
In this article, we first discuss the principles governing the appropriate income tax treatment of work-related costs and the application of those principles to child care. We then briefly describe the federal child care tax credit, on which many state child care tax provisions are based. We proceed to summarize the various states’ child care tax provisions and describe changes recently enacted or proposed in three states. We also report some basic esults on factors associated with states’ decisions on whether to provide tax relief for child care costs. We conclude with policy recommendations.