Child Tax Credits Pay for Themselves via Reduced Future Government Spending & Increased Tax Revenue

Three decades of evidence from the U.S., UK, and Canada proves tax credits don't just reduce child poverty; they fundamentally reshape life trajectories from birth through adulthood.

Photo by Fé Ngô on Unsplash

Historic shifts from traditional welfare to work-based tax credits in the 1990s created natural experiments across three nations. Tax Credits and Child Outcomes: Lessons from the U.S., U.K., and Canada by Katherine Michelmore’s results are definitive: children exposed to these credits experience cascading benefits throughout their lives, with programs essentially paying for themselves through reduced government spending and increased tax revenue from higher-earning adults.

The big picture: At the turn of the 21st century, Western nations shifted away from unconditional cash transfers toward benefits that encourage or require work. Critics claimed traditional welfare created a "culture of dependence." The new tax credits aimed to support low-income families while incentivizing employment.

How programs pay for themselves:

• Reduced healthcare spending: Better infant health, fewer childhood health issues, improved adult health outcomes

• Lower child welfare costs: 8% reduction in foster care time, 3% fewer Child Protective Services referrals

• Decreased social service needs: 5 percentage point reduction in adult poverty

• Increased tax revenue: $550/year higher earnings, 3pp more employment, 4.2% more college graduates

Program Details

U.S. Programs:

Earned Income Tax Credit (EITC):

• Implemented 1975, initially worth $500 ($3,000 in 2023 dollars)

• Trapezoidal benefit structure: phase-in, plateau, phase-out

• 2023 maximum: $7,430 for married couple with 3 children earning under $63,398

• Benefits vary by number of children (max 3)

• 32 states offer supplemental EITCs (3% to 100%+ of federal)

• Claimed during tax filing (up to 15-month delay from eligibility)

• 26 million families claim $60 billion annually

• Nearly half of families with children claim it yearly

Child Tax Credit (CTC):

• Established 1998 at $400 per child under 17

• Historically nonrefundable with income restrictions

• 2023: $2,000 per child, 70% of children eligible

• 2021 temporary expansion: $3,600 (under 6), $3,000 (6-17), 90% eligible

UK Programs:

Working Family Tax Credit (WFTC):

• Replaced Family Credit in 1999

• Required 16+ hours/week work

• More generous than FC, especially for children under 10

• Lower phase-out rate (55% vs 70%)

• 70% childcare subsidy included

• Payment shifted from mothers to fathers

Post-2003 split:

• Child Tax Credit (CTC): No employment requirement

• Working Tax Credit (WTC): Employment-based, not child-based

• Universal Credit replacing both by 2024

Average benefits increased from £3,500 (1992) to £7,500 (2016)

Canadian Programs:

Canada Child Tax Benefit (CCTB) 1993-2015:

• ~$1,500 per child in 2014

• Monthly distribution based on prior-year income

• Full benefit below $45,000 CAD

• Phase-out: 2% (one child), 4% (two+ children)

• No work requirement

National Child Benefit (NCB) 1998-2015:

• Supplement to CCTB

• $2,000 per child by 2015

• Steeper phase-out rates: 12.2%-33%

• Federal-provincial partnership

• Provincial variation in implementation

Canada Child Benefit (CCB) 2016-present:

• Replaced previous programs

• 2022: Up to $7,000 (under 6), $6,000 (6-17)

• Phase-out begins at $33,000 CAD

• Monthly direct deposit/check

Ontario benefits increased from $4,000 (1990) to $14,000 (2014) for two-child households

Research Methodologies

Empirical Strategies:

U.S. Approaches:

• Difference-in-differences: 1990s federal expansion comparing 2+ child vs 1 child families

• State EITC variation: Staggered implementation across states

• Simulated benefits: Combining federal/state variation over time

• Instrumental variables: Using EITC variation to instrument for income changes

• Regression discontinuity: December vs January births (15-month benefit delay)

• Regression kink design: Exploiting EITC schedule nonlinearities

• Long-run exposure: Cumulative benefits throughout childhood

UK Approaches:

• Evaluating FC to WFTC transition

• Challenge: Concurrent policies (minimum wage, childcare expansion)

• Difference-in-differences comparing low vs high-income families

Canadian Approaches:

• Simulated benefits using NCB introduction

• Provincial variation in implementation

• Tax calculators for benefit simulation

Data Sources:

• U.S.: Vital Statistics, NLSY, PSID, FFCWS, CPS, ACS, administrative tax/school data

• Canada: NLSCY, Survey of Household Spending

• UK: Various administrative sources

Mechanisms and Intermediate Effects

How Tax Credits Work:

Tax credits operate through two primary channels that often work in opposing directions. The income effect provides direct transfers that increase family resources, operating through both a "resources channel" where families purchase educational materials, nutritious food, and healthcare, and a "family processes channel" that reduces stress and improves parental health. The substitution effect alters parent-child time through work requirements, with outcomes depending heavily on the quality of alternative childcare arrangements and broader contextual factors.

Expenditure Patterns:

Research across all three countries reveals remarkably consistent spending patterns that challenge stereotypes about low-income families. In the U.S., families increase purchases of fresh fruits and vegetables following credit disbursement, invest in large durables like used cars, and reduce debt holdings. The 2021 CTC expansion showed families spending $75 of every $100 received on food, housing, and child goods. Canadian evidence demonstrates increased education spending on computers and tuition, higher transportation and childcare costs, and more home food consumption; all while reducing alcohol and tobacco spending. UK families similarly increased spending on food, housing, transportation, and child-specific items like footwear, clothing, and books, while also consuming more fruits and vegetables and reducing alcohol and tobacco purchases.

Labor Supply Effects:

The employment impacts vary significantly by family structure and country. Single mothers increased employment in both the U.S. and UK following credit expansions, while married mothers showed slight employment reductions in the U.S. and Canada but no change in the UK. Notably, the 2021 CTC expansion in the U.S. produced no negative employment effects despite lacking work requirements, challenging assumptions about unconditional transfers.

Parental Health and Family Structure:

Tax credits generate substantial improvements in parental wellbeing that likely contribute to better child outcomes. U.S. research documents better self-reported health, fewer poor mental health days, and reduced inflammatory biomarkers among recipients. UK evidence shows improved mental health particularly for lone mothers. Effects on family structure remain mixed, with U.S. evidence showing small impacts on marriage and divorce in either direction, while UK data suggests lower re-partnering rates among single mothers.

Short-Term Child Outcomes

Child Poverty Reduction:

U.S.:

• 6+ million lifted above poverty line annually (half children)

• Hoynes & Patel: 50% underestimate due to labor supply effects

• $1,000 increase reduces poverty 8.4 percentage points

UK:

• 30%+ child poverty decline post-WFTC

• Particularly for working households

Canada:

• CCB reduced child poverty across multiple measures

• Single mother households especially benefited

Infant Health:

Birthweight Improvements:

• $1,000 EITC increase: 2-3% reduction in low birthweight

• 6.4 gram average increase

• Reduced preterm births

• Better APGAR scores

Mechanisms:

• Increased prenatal care visits

• Reduced maternal smoking/drinking

• Shift to private health insurance

2021 CTC:

• $100 monthly increase: 2-3% low birthweight reduction

• Larger effects than EITC (no work requirement)

Childhood Health:

Insurance Coverage:

• $100 state EITC increase: 4pp increase in private insurance

• Offset by public insurance decrease

• Shift in coverage type, not total coverage

Health Status:

• 1.2pp decrease in fair/poor health (35% reduction)

• 3.4pp increase in excellent health

• Mother-reported improvements ages 6-14

Child Maltreatment:

• $1,000 first-year income increase:

  • 3% fewer CPS referrals (first 3 years)

  • 8% less foster care time

  • Effects persist through age 8

Canadian Evidence:

• Boys: Significant physical health improvements

• Girls: Mental health improvements

• Reduced food insecurity

• Maternal mental health improvements

Education:

Test Scores:

• $1,000 EITC income: 6% SD increase math/reading (ages 5-14)

• Larger effects: Unmarried mothers (8%), Black/Hispanic (8%), boys (9%)

• Girls: 4% SD increase

• Canada: Similar positive effects for less-educated mothers

Income vs Employment Effects:

• Agostinelli & Sorrenti: $1,000 income → +4.4% SD test scores

• 100-hour work increase → -6% SD test scores

• Break-even wage: $13.50/hour (2000 dollars)

College Enrollment:

• $1,000 cash-on-hand pre-graduation: 1.3pp increase (4.3%)

• Context: 50% U.S. college graduation rate

Long-Term Outcomes

The long-term outcomes demonstrate how childhood investments compound over time, generating the increased tax revenue and reduced government spending that make these programs self-financing.

Educational Attainment:

Higher educational attainment directly translates to increased lifetime earnings and tax contributions.

• $1,000 EITC exposure ages 13-18:

  • 1.3% more likely to complete high school

  • 4.2% more likely to complete college

• Larger effects: Low-income households, less-educated parents, Black children

• Multiple pathways beyond test scores

Employment and Earnings:

These employment and earnings gains generate the tax revenue that helps offset program costs.

• $1,000 EITC exposure ages 13-18: $550/year higher earnings mid-20s (2%)

• $1,000 annual exposure birth-15:

  • 5pp reduction in adult poverty

  • 3pp increase in employment (ages 25-45)

• First-year exposure: 1-3% earnings increase (mainly men)

Health Outcomes:

Better adult health reduces long-term healthcare costs while enabling higher workforce participation and earnings.

• $100 annual childhood EITC:

  • 1.7pp more likely "good/excellent" health (2.6%)

  • 0.8pp less obesity (4.1%)

  • 0.4pp fewer functional limitations (9%)

  • 0.2pp less uninsured (2.6%)

  • Suggestive: 1.4pp less high blood pressure ages 38-51 (7.2%)

Critical Research Gaps

The most glaring limitation in current research is the near-complete absence of long-term evidence from outside the U.S. context. While short-term effects have been documented in Canada and the UK, we lack rigorous evidence on how these programs affect children into adulthood. This gap stems partly from data limitations and the multiple policy changes in both countries that make isolating specific program effects challenging. Understanding long-term impacts across different institutional contexts would significantly strengthen our knowledge base.

The mechanisms driving observed improvements remain frustratingly unclear. While we know tax credits improve outcomes, disentangling whether benefits flow primarily through increased income or parental employment remains elusive. Work requirements create particularly complex dynamics, they may enhance outcomes through modeling work behavior and providing health insurance access, yet potentially harm children through reduced parent-child time. The most vulnerable families who cannot meet work requirements may be entirely excluded from benefits, yet we know little about how this affects them. Context clearly matters, as evidenced by contrasting findings between the U.S. and Norway on maternal employment effects, but we need more precise understanding of which contexts favor which mechanisms.

Questions of heterogeneity demand more attention. The optimal age for intervention remains contested, with evidence supporting both early life exposure (affecting infant health and maltreatment) and adolescent exposure (affecting college enrollment and earnings). Understanding effects across the income distribution poses methodological challenges due to endogeneity concerns, requiring creative approaches like pre-exposure income measures or predicted permanent income.

The distribution method itself (annual lump sums versus monthly payments) represents another crucial unknown. U.S. families often prefer lump sums as forced savings enabling durable goods purchases, yet face significant credit constraints and income volatility that monthly payments could address. The stark differences between December and January births demonstrate timing's importance, while the 2021 CTC expansion offers a unique opportunity to compare distribution methods directly.

Methodological concerns also plague the literature. Recent advances highlighting problems with staggered treatment rollout designs haven't been incorporated into EITC research, partly because appropriate estimators for continuous treatments don't yet exist. Studies using instrumental variables often rely on questionable exclusion restrictions, while cumulative exposure studies cannot examine pre-trends to validate their designs.

Policy Design Implications

The accumulated evidence offers clear guidance for policymakers while highlighting remaining uncertainties. Most fundamentally, these programs demonstrably "pay for themselves" through reduced future government spending on health, criminal justice, and social services, combined with increased tax revenue from higher-earning adults. This finding should reshape cost-benefit analyses of social programs.

Work requirements emerge as a double-edged sword. While they increase employment and potentially provide positive role modeling and health insurance access, they also reduce parent-child time and may exclude the most vulnerable families entirely. The contrast between U.S. and Canadian programs suggests that pure income transfers can achieve similar benefits without employment mandates, though context, particularly childcare quality and availability, matters enormously.

Distribution frequency affects both program uptake and spending patterns. Monthly payments enable consumption smoothing and reduce financial stress, while annual lump sums facilitate major purchases and serve as forced savings. The optimal approach likely varies by family circumstances and local economic conditions.

Cross-country comparisons reveal how institutional contexts shape program effects. Canada's no-work-requirement model cleanly demonstrates income effects, while UK's hours requirements create different incentive structures than the U.S. earnings-based approach. The rich variation across U.S. states provides natural experiments, but findings may not generalize to different institutional environments.

Future research priorities should focus on disentangling income from employment effects, perhaps through creative instrumental variables strategies or by studying programs with different designs. Identifying optimal intervention timing requires longitudinal studies tracking the same children through multiple developmental periods. Understanding distribution frequency impacts necessitates experimental or quasi-experimental variation in payment timing. Perhaps most critically, we need better data on excluded populations; those who cannot meet work requirements or don't file taxes; to understand the full distributional impacts of these programs.

The Bottom Line: Three decades of rigorous research across three nations definitively proves that child tax credits pay for themselves by reducing future government spending and increasing tax revenue. These programs transform children's lives while generating fiscal returns that exceed their costs. From reducing infant mortality and foster care placements to increasing adult earnings and tax contributions, these investments create lasting change that benefits both individuals and government budgets. While questions remain about optimal design, the core finding is clear: child tax credits are not expenses but investments that generate positive returns for society.