Can CDCTC Policies Increase Child Care Supply?

On average, almost a third of parents considering using formal child care (care provided in a center or home-based care) cannot find a place for their child. This is a problem for parents and the economy: about 70% of children under six have working parents. Beyond losing the long-term child development benefits of quality early childhood programs, insufficient child care supply has serious consequences for gender equality, family incomes, poverty alleviation efforts, local economies, and spatial inequities: Rural and low-income areas face larger child care shortages than urban or higher-income neighborhoods. One study estimated that the U.S. economy loses $122 billion per year from the infant and toddler (0-3) child care supply shortage alone—estimated in lost parental earnings, business and tax revenues. Although it is generally agreed that public funding is needed to address the child care supply shortage, whether demand- or supply-side policies (or a combination of both) ought to be used is debated by early childhood education experts.

The Child and Dependent Care Tax Credit (CDCTC) is one demand-side policy which helps offset a portion of families’ child or dependent care expenses by reducing their federal or state income tax liabilities. This blog presents the findings of a new study that analyzed the association between state CDCTCs and the level of child care supply to address demand-side concerns.

Demand-Side Child Care Policies

In the formal child care market, providers expand supply (i.e. add child care slots) to meet the care needs of families (demand). (Note: Formal care is paid care provided by an individual, licensed center, or family-based provider, while informal care is provided by a child’s parents, relatives, friends, or neighbors.) One key challenge in modeling child care demand is the difference between potential and actual demand. For example, a low-income community with many single working parents may have high potential need for formal child care, but little financial capacity to acquire it. This population can be characterized as having “latent” demand. It should be noted that, because some parents will always prefer to use informal child care, some degree of a child care gap will exist.

Child care decision-making is a dynamic and complex process filled with trade-offs and influenced by family ideology, employment status, income, and race/ethnic background. That said, latent demand contributes to the size of the current child care supply gap. BPC found in a 2022 survey of parents using informal care that approximately 40% were doing so because they found formal care inaccessible, particularly with regard to cost. This suggests that the equilibrium at which the child care market currently clears is not where it would clear for low-income families: Formal care would be in higher demand if child care was cheaper or if families had a greater ability to pay. However, due to the unique constraints of operating a child care business, providers cannot further lower prices (they are already under-charging for the true cost of delivering care).

Income, therefore, influences formal child care consumption and, by extension, drives supply. According to economist David Blau, increases in income are shown to increase utilization of formal child care: As family income increases, families tend to increase their use of paid child care and switch to center care from other types of formal and informal care. The White House recently found that higher-income families are more likely to pay for and receive child care than lower income ones. There is also substantial evidence that lower-income families are more likely to use informal care than higher-income families: 62% of families at or above the federal poverty line (FPL) use formal child care, compared with 50% of families below the FPL. This is because parents unable to find child care at the price they are willing to pay will exit the market and opt for informal care. As a result, higher income areas have more formal child care options. Demand-side policies such as tax credits and subsidies, therefore, increase parents’ willingness/ability to pay (a shift of the demand curve) and, theoretically, given that child care supply is shown to be elastic, this allows more supply to be filled at higher prices.

New Research on Supply-Side Effects of CDCTC

Given the impact of increases to income on child care utilization, a federal tax deduction that would later become the CDCTC was implemented in 1954 to support parent choice and ease the costs of formal child care. The federal CDCTC reimburses working (or employment-seeking) families for 20% to 35% of their formal child care expenses (families may claim up to $3,000 of expenses per child) depending on the family’s adjusted gross income (AGI) by reducing their household’s tax liability. Like other American early childhood policies, the CDCTC aims to incentivize parents to enter the labor force—the amount of credit claimed cannot exceed the income of the second spouse—and help them to pay for formal care. In a study of the federal CDCTC’s effects on married women’s employment and child care decisions, David C. Ribar, professor at George State University, found that the CDCTC had a modest positive effect on married women’s labor supply and a stronger positive effect on their paid care utilization. This effect on paid care utilization was especially prevalent among part-time married women workers. In other words, the CDCTC constitutes a positive shift of the demand curve by increasing both women’s employment and income—filling some of the latent demand resulting from an inability to pay.

On top of the federal program, 30 states instituted their own child care related tax credits. We explored whether increases in generosity of state CDCTCs are associated with increases in the level of child care supply and demonstrates the importance of state programs. This analysis used total slot data for 2,211 counties from 2019 to 2022 in the U.S., acquired directly from and approved by 36 state Child Care and Development Fund (CCDF) administrators.^[1] Bearing in mind statistical caveats, this study suggests that there is a relationship between state CDCTC generosity and the level of child care supply in a county.^[2] This relationship is curvilinear, meaning that at different values, the tax credit is associated with different changes in supply levels (in other words, tax credit values of $50 and $500 are associated with different size increases in the number of slots), with results significant at the 95% confidence level. Given how low the state CDCTC values are compared with how much families pay for care, we cannot determine what the precise effect on supply is at this time. Nevertheless, this research shows how intertwined issues of affordability and supply are.

Federal Policy Recommendations

This research leads to three recommendations on how to improve the federal credit, largely in line with the changes of the 2021 American Rescue Plan Act (ARPA) CDCTC expansion: make the federal CDCTC refundable, increase the credit rate and maximum expenses claimed, and adopt a monthly payment schedule.

(1) Refundability

Currently, the federal CDCTC is nonrefundable, meaning that moderate- and high-income families are most likely to obtain the full credit because they are generally the ones with a tax liability equal to or greater than the value of the credit. With a refundable credit, by contrast, if a family’s tax credit exceeds their tax liability, they receive the difference as a tax refund (making the credit function like a cash transfer to those families), rendering the program and, by extension, formal child care, accessible to more low-income families. Prior research has found that expansions in generosity like refundability and increases to maximum expenses that can be claimed under the federal CDCTC led to moderate effects on part-time employment rates among married women and large effects on part-time paid care utilization. In other words, the expansion enabled stay-at-home mothers to purchase formal care and begin working (if only part-time).

One model suggests that refundable state CDCTCs could be associated with as large as a 9% increase in child care supply levels compared with nonrefundable credits (statistically significant at the 90% level). Changes to refundability at the state level can potentially help families who are ineligible for or unable to receive the federal child care subsidy program but are still struggling to afford formal child care. About half of states with CDCTCs have made their credits refundable and all other states, as well as the federal government, should consider following suit.

(2) Increase Credit Rate and Expenses Claimed

The level of the tax credit is far too low given the cost of child care: The maximum reimbursement amount per child is currently $1,050. However, the mean cost of child care in the U.S. is $12,304 per year for infant center-care and $10,001 for center-care for a 4-year-old child. Affordability remains a major concern for families: In general, working parents with children under the age of six spend about 10% of their income on center-based care. This portion of the family budget grows more drastic for low-income parents, who spend approximately 28% of their incomes on center-based care. This could be partially rectified by increasing the value of the expenses and the percentage of them that can be reimbursed by the CDCTC.

Fortunately, there is a model for this: The ARPA expansion of the CDCTC raised the maximum expenses claimed from $3,000 to $8,000 for one dependent, and from $6,000 to $16,000 for two or more dependents. It also raised the credit rate to 50% for families earning less than $125,000 per year. In other words, the maximum CDCTC value per child under the ARPA expansion for a low-income family is $4,000. Once combined with refundability, this could substantially help low-income families afford child care.

(3) Payment Schedule

The payment schedule of the CDCTC should also be reconsidered. Child care expenses are often ongoing and monthly; however, the CDCTC is paid out once a year. This annual payment schedule does not help families who are living paycheck to paycheck. There are successful models for potentially adjusting the CDCTC’s payment schedule: The ARPA expansion of the Child Tax Credit gave parents the option to receive their payments monthly, which helped families with ongoing expenses, like food. States and the federal government should consider whether an option for a more frequent CDCTC tax credit payment schedule might better suit in this case as well.

Reforming the CDCTC in isolation will not solve our nation’s child care crisis. A combination of demand- and supply-side solutions are necessary to decrease the size of the child care supply gap.

Still, policymakers ought to consider the CDCTC’s potential to reshape the child care market in the near term, given that it can help reduce costs for families, enabling them to access quality formal child care and, by extension, supporting the long-run growth of child care supply.

Read the full study here.

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Biography:

Maya Jasinska is a recent graduate of the University of Oxford’s Master of Science in Comparative Social Policy program. This study served as her Master’s dissertation, and the full project can be read here. She previously interned with the Bipartisan Policy Center’s Early Childhood Initiative.  

[1] This data was acquired as part of the “Child Care Gap” report, funded by the Buffett Foundation (2021). Many thanks to Linda Smith and Anubhav Bagley for permission to use this data.

[2] Controls included: GDP/capita, women with children under six’s labor force participation rate, median income, racial demographics, poverty level, number of multigenerational households, and quality regulations per county.