Early Childhood Education

Child-care Subsidies and Tax Provisions

 

Making child care affordable and employment possible for parents, while supporting positive development of children, has become an increasingly important public policy goal in the United States since the 1960s. To these ends, the federal and state governments have enacted a succession of legislation to directly subsidize child care and early education, as well as tax provisions to offset childcare costs. Subsidies have typically targeted low-income parents—with children through age 12—who are employed or preparing for employment. Tax provisions have been aimed at working families of all economic levels.

Subsidies take two basic forms. Widespread today are portable public payments that follow children—often called “voucher” payments—to help pay for child-care arrangements eligible families make for their children. The second are publicly financed child-care and early education programs—sometimes known as “contract” centers or family child-care networks. More common in the early decades of child-care subsidies in the United States, these programs are available to eligible families at low or no cost.

The two main child-care tax provisions that benefit families are tax credits for child-care expenses and employer-sponsored accounts of untaxed earnings that employees set aside to reimburse child-care costs.

 

Child-care Subsidies

Major federal programs that allocate funds to states for child-care subsidies and the primary families they target have included (chronologically) the following:

• Social Services Block Grant (SSBG) (1981-present). For low-income working families.

• Aid to Families with Dependent Children (AFDC)/JOBS Child Care (1988-1996). For families receiving AFDC and employed or participating in approved education, training, work preparation activities.

• Transitional Child Care (1988-1996). For families leaving AFDC for employment, for one year.

• At-Risk Child Care (1990-1996). For families at risk of receiving AFDC cash assistance.

• Child Care and Development Block Grant (CCDBG) (1990-1996). For low-income working families.

• Child Care and Development Fund (CCDF) (1996-present). Called CCDF by the Department of Health and Human Services, this 1996 amendment to CCDBG combined AFDC/JOBS, Transitional, At-Risk, and CCDBG child care and aimed to serve low-income working parents with and without connections to cash assistance.

• Temporary Assistance for Needy Families (TANF) Child Care (1996-present). For families receiving TANF and other needy families working or preparing for work receive direct TANF child-care subsidies. Most states also transfer unspent TANF funds to CCDF; some transfer to SSBG as well.

Two other major federal programs that support child care and early education are the following:

• Head Start (1965-present). For families at or below the federal poverty level, with children three years old to kindergarten entry. Designed to help break the cycle of poverty, Head Start provides a free, comprehensive child development program to meet children’s emotional, social, health, nutritional, and psychological needs and works closely with parents. The federal government awards grants to local public agencies, private organizations, Indian Tribes, and school systems to operate Head Start programs at the community level. Usually part-day and part-year, Head Start programs help some participating employed parents meet some of their childcare needs. Particularly after the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of 1996 began moving more low-income mothers into the workforce, Head Start programs increasingly looked for ways to extend their service days, sometimes with wrap-around CCDF funding.

• Child and Adult Care Food Program (CACFP) (1968-present). For child-care providers serving children of low- and middle-income families. Participating providers receive reimbursements for the costs of meals and snacks—with higher reimbursements for low-income children, communities, or family child-care providers.

Spending for federal child-care programs increased substantially with the 19881990 creation of CCDBG, AFDC/JOBS, Transitional, and At-Risk child care—the last three responding to new work requirements for AFDC recipients. Head Start spending also began growing steadily in the early 1990s. Another, even larger, boost in child care spending came with the passage of CCDF in 1996, companion legislation to PRWORA, which replaced AFDC cash assistance with time-limited TANF benefits. Between 1997 and 2001, total federal and related state spending for CCDF, TANF, SSBG, Head Start, and CACFP rose to 69 percent, from about $11.1 billion to nearly $18.8 billion (in 2002 dollars). Growth slowed starting in 2001, reaching $20.4 billion in 2003—84 percent for the seven-year period (Table 1, U.S. Department of Health and Human Services).

Spending totals for CCDF and TANF child care include state and some county expenditures in maintenance-of-effort and matching funds. A number of states also regularly spend above the amounts required to receive their maximum CCDF allocations from the federal government. A few localities also support child-care subsidies, often serving families with incomes above eligibility cutoffs for state subsidy programs.

In 2003, the CCDF, TANF, SSBG, and Head Start programs paid for care for over 3 million children—CCDF 1.75 million; TANF 475,000; SSBG 38,000; Head Start about 900,000. The CACFP reimbursed meal and snack costs for 2.91 million children, many in child-care centers and homes that also received subsidies for child-care services. Despite these impressive numbers served, many eligible children do not receive subsidies. With the exception of CACFP, none of these programs is an entitlement. (While all licensed and approved providers serving low- and middle-income children are entitled to participate in CACFP, many do not apply or are not approved.)

In the early 1990s, states began establishing prekindergarten programs. Like the contracted centers and family child-care networks established early on with SSBG funding and like Head Starts, prekindergartens are publicly supported programs. In the 1991-1992 school year, pioneering states spent an estimated $700 million on free, part-day, part-year programs, mainly for disadvantaged four-year-old children at risk of low school achievement. By the 2002-2003 school year, thirty-eight states spent about $2.54 billion to serve approximately 740,000 children. Some states were also serving three-year-olds, and five states were moving to universally available services for children of all income levels. Although prekindergarten services are often offered in public schools, twenty-eight states make provision for prekindergarten in community-based child-care settings (National Institute for Early Education Research, 2004). Like Head Start programs, prekindergarten programs help fill some child-care needs for employed parents.

Portable voucher subsidies—not tied to particular programs—came into increasing use with the establishment of the AFDC/JOBS, Transitional, and At-Risk child-care programs and the accompanying expansion of funding. Voucher use grew even more with creation of the CCDF, which emphasizes parent choice of care and charges states to make subsidies available for all legal forms of care that meet basic health and safety requirements. States may exempt otherwise unregulated care by relatives and in children’s own homes from these requirements, or they may set up more stringent requirements. Most states make voucher payments directly to child-care providers, though a few make some payments to parents to pass on to caregivers.

CCDF gives states great flexibility on key subsidy policies, issues central to operating any subsidy program within available financial resources:

• Income eligibility: While CCDF sets the maximum income eligibility ceiling at 85 percent of State Median Income (SMI) based on family size, states typically set lower ceilings as they strive to stay within their budgets. In 2002, the average state eligibility ceiling was 62 percent of SMI, and most families served across the county had incomes well below this level.

• Work and training requirements: Unless subsidies are provided for reasons related to child welfare, CCDF requires that participating parents be working or involved in training or education, but gives states broad discretion in defining these activities.

• Service rationing: CCDF gives no categories of families’ entitlement to subsidies, as did the predecessor AFDC/JOBS and Transitional programs. Virtually all states, however, continue to guarantee subsidies to families connected to cash assistance. Further, about half the states have a commitment to serve all state-eligible families who apply, although—like all states—they may lower eligibility ceilings in response to budget shortfalls. The remaining states typically maintain waiting lists.

• Provider payment rates: CCDF asks states for evidence that their maximum payment rates give subsidized families access to a major portion of the child-care market in their communities. Though states are required to conduct Child Care Market Rate Surveys, budget limitations often force them to set rates lower than those indicated by the surveys.

• Parent copayments: Subsidized parents pay a portion of the state rate for their care—based on a sliding scale that typically takes into account income, family size, and number of children in care. There are significant state differences among copayment scales and in the percentage of income required for copayments from families at similar income levels. Also, when cost of care exceeds the maximum rate, parents normally pay the difference.

 

Child-care Tax Provisions

The following two tax mechanisms assist working families with child-care costs:

• Federal and state Child and Dependent Care Tax Credits (1976-present, federal).

• Federal Dependent Care Assistance Plan (1981-present).

The federal Child and Dependent Care Tax Credit reduces the taxes of working families with child-care expenses. Eligible families must incur expenses for the care of a child under age 13—or of an older dependent unable to care for himself or herself—in order to work or look for work. Twice since its enactment in 1976, the credit has been increased and made more progressive. Beginning in 2003, families with incomes up to $15,000 may claim an annual credit of up to $1,050 for one child (35% of a maximum of $3,000 in expenses) and $2,100 for two or more (35% of $6,000 maximum). Families with higher incomes may claim progressively lower percentages of their child-care expenses. At $43,000 and above, the maximum credit for one child is $600 (20% of $3,000) $1,200 for two or more (20% of $6,000). The credit cannot exceed what a family owes in taxes, and no benefit is provided to families whose incomes are so low that they pay no taxes. Thus, low-income families typically do not receive the credit’s full benefit (Burman, Maag, and Rohaly, 2005). In federal fiscal year 2003, the U.S. Treasury lost an estimated $2.7 billion in forgone revenue due to the credit, an amount slightly higher than that year’s child-care subsidy expenditures from TANF.

By 2004, twenty-seven states also offered a child and dependent care tax credit or tax deduction. Most states’ tax credits are structured as a percentage of the federal credit or as a percentage of the care expenses eligible for that credit. Unlike the federal government, thirteen states with child and dependent-care tax provisions offer refundable credits, benefiting even families with incomes too low to owe state income taxes. Maximum annual values for 2004 ranged from $288 to $2,310 for a family with two or more children. Twelve states offered nonrefundable credits, and three offered deductions of child care expenses. (One state offered both.)

The federal Dependent Care Assistance Plan (DCAP) can benefit families of all income levels. Employees whose employers have set up DCAP plans may put aside up to $5,000 of their earnings each year, tax-free. They may then draw up these accounts to reimburse their documented child-care expenses. In federal fiscal year 2003, estimated revenue loss to the Treasury from DCAPs was approximately $577 million.

Although not specifically tied to child-care expenses, federal and state Earned Income Tax Credits and federal Child Tax Credit also extend the resources available to low-income families. See also Preschool/Prekindergartern Programs.

Further Readings: Blank, Helen, Karen Schulman, and Danielle Ewen (1999). Seeds of success: State prekindergarten initiatives, 1998-1999. Washington, DC: Children’s Defense Fund; Burman, Leonard E., Elaine Maag, and Jeffrey Rohaly (2005). Tax subsidies to help low-income families pay for child care, Discussion Paper No. 23. Washington, DC: Tax Policy Center; Collins, Ann M., Jean I. Layzer, J. Lee Kreader, Alan Werner, and Fred B. Glantz (2000). National study of child care for low-income families: State and community substudy interim report. Cambridge, MA: Abt Associates; National Center for Children in Poverty. Federal Child and Dependent Care Tax Credit. November 2005. Available online at http://www.nccp.org/policy_index_14.html: National Center for Children in Poverty. State Child and Dependent Care Tax Credit. November 2005. Available online at http://www.nccp.org/policy_index_15.html; National Institute for Early Education Research (2004). The state of preschool: 2004 State preschool yearbook. New Brunswick, NJ: The State University of New Jersey, Rutgers; Schulman, Karen, and Helen Blank (2005). Child care assistance policies 2005: States fail to make up lost ground, families continue to lack critical support. Washington, DC: National Women s Law Center; U.S. Department of Health and Human Services, Administration for Children, Youth and Families, Administration for Children and Families (August 2005). Federal and State child care expenditures (1997-2003): Rapid growth followed by steady spending. Maryland: University of Maryland Foundation.

Lee Kreader