Best practices

Child benefit design: the importance of refundable tax deductions

Child benefits appear to reduce child poverty and improve the situation of children and their families, both educationally and health-wise. The evidence also indicates that they have a positive (but small) effect on the birth rate. However, the way these benefits are designed is crucial when it comes to activating all their potential.

Factsheet

 

  • Geographical scope: OECD countries.

1. Context

In the sphere of family policy, recent years have seen an increase in policies geared towards particular groups (mostly low-income households), at the expense of universal policies (targeting the population as a whole). Increased use of tax instruments is also found.

2. Debate

As the extension of tax instruments is to some extent related to a reduction in direct child allowance, their use (and particularly their design) has direct consequences in redistributive terms and on the progressivity of the tax system. Nevertheless, two different approaches are observed that rest on conflicting logics:

  • Non-refundable tax benefits. These reduce the tax liability. Basically they favour medium and low-income households; however, households with no or very low income, which have no
    tax liabilities or a very light tax burden, hardly benefit from these deductions.

  • Refundable tax benefits. These also reduce taxes, but when the deduction is greater than the tax liability the difference is credited as a net allowance. Deductions for maternity or large families are examples of such benefits, which favour all households to which they are applied, regardless of income.

On the whole, concessions or reductions on taxable income are considered to be regressive, as they mostly favour higher-income individuals. In contrast, tax credits are neutral or moderately progressive, as they are of a more equitable nature, insofar as they tend to represent a larger percentage of the fiscal balance for lower-income individuals.

However, the impact of these tax instruments, from a redistributive viewpoint, is unclear and unforeseeable, as they are closely related to the rest of the characteristics of the tax system (rates, the possibility of filing tax returns jointly or individually, exempt bases), which makes their use as redistribution tools inadvisable. Nevertheless, the refundable nature of some of these deductions marks a radical change in their redistributive capacity. Refundable tax benefits are strongly progressive, independently of the setting in which they operate.
 

3. Conclusions

Although neither concessions nor deductions are particularly effective as redistribution tools, refundable tax credits targeting low-income households do perform this function. In this respect, several analyses of the system of family and child benefits and deductions in Spain highlight the weak redistributive capacity of these tax instruments. They are unable to exert a significant effect on the reduction of poverty, as a large part of the households that lie below the poverty threshold are exempt from filing an income tax return.

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