Proposed Tax Incentive for Payers of Child Support
Promoting Perceptions of Fairness

By Paul D. Hutchison, Gary M. Fleischman, and Susan B. Anders

E-mail Story Print Story

Examining the Problem

The societal problems involving child support are well known, yet continue despite the passage of four major federal laws passed between 1975 and 1996 that had been designed to improve matters. A recent article (Anne C. Case, I-Fen Lin, and Sara S. McLanahan, “Explaining Trends In Child Support: Economic, Demographic, and Policy Effects,” Demography, 2003) summarizes the issue succinctly:

When parents live with their child, they automatically share their income with the child. When parents live apart, income sharing is not automatic, and the non-resident parent often fails to provide for the child. Court-ordered child support is the mechanism through which society attempts to ensure that non-resident parents make financial transfers to their children. The importance of child support has increased dramatically during the past four decades as more and more children become eligible for child support.

Child support is a major factor in keeping children in single-parent homes out of poverty. For 2002 (the most recent data available), the U.S. Census Bureau reported that 5.7 million people in the United States paid approximately $22 billion in child support, with an average of $3,200 received annually per custodial family (see www.census.gov/
prod/2005pubs/p70-99.pdf). Not all child support obligations are met, however. The U.S. Census Bureau report for 2001 indicated that 25% of single mothers received no child support at all (see www.census
.gov/prod/2003pubs/p60-225.pdf). Approximately 1.7 million of the custodial parents due child support did not receive any payments, and approximately $13 billion dollars went uncollected. Research has shown that custodial parents of children born outside of marriage are even less likely to receive child support than former spouses (Judi Bartfeld, “Falling Through The Cracks: Gaps in Child Support Among Welfare Recipients,” Journal of Marriage and Family, February 2003). Furthermore, separated parents with multiple children are generally not successful in obtaining support for all of their children. The 2002 U.S. Census Bureau report indicates that 62% of noncustodial parents support only one child.

Three Approaches to Ensure Child Support Compliance

The following are three theoretical approaches to increase child support payment compliance (I-Fen Lin, “Perceived Fairness and Compliance with Child Support Obligations,” Journal of Marriage and Family, May 2000):

Deterrence. This is a punitive approach that attempts to increase child support payments by identifying offenders after the fact, often using civil or criminal charges to punish persons who do not comply with legally mandated child support payment schedules. Payment of child support obligations is encouraged by punitive legal enforcement mechanisms, as well as by increased fear of punishment. While this approach may increase overall child support payments, it is paternalistic in nature and involves significant adverse societal externalities such as jailing and property liens against offenders.

Compliance. This approach is a before-the-fact method, using standards and enforcement to monitor a noncustodial parent’s child support payment behavior before violations occur. An example of this approach would be automatic withholding of child support payments from noncustodial parent paychecks. This approach has been shown to increase child support payment compliance, although it is again paternalistic and arguably condescending. It also sends a message that noncustodial parents as a group cannot be trusted to comply with their legal obligations, which likely negatively affects payer attitudes. Research has shown that enforcement can actually reduce voluntary payments (Laura M. Argys and H. Elizabeth Peters, “Can Adequate Child Support Be Legislated? Response to Guidelines and Enforcement,” Economic Inquiry, 2003).

Consensus. This final approach is not paternalistic like the other two methods, and does not require “fear” tactics. This more enlightened approach attempts to align a child support payer’s personal norms of behavior with societal norms. The consensus-based approach attempts to convince noncustodial parents that payments of child support are “the right thing to do” and that the obligation results from a fair and just legal process. In essence, child support payer behavior is changed by the ways that the law is enforced so that the legal process itself increases perceptions of fairness and thus enhances compliance. Fathers’ advocacy groups often cite a lack of fairness in the legal process as a key reason noncustodial fathers do not pay child support.

Perceptions of Fairness

Perceptions of child support payment fairness focus on the ability of the payer to reasonably afford the assessed child support payments, as balanced by the needs of the custodial parent and the child (see Lin). Research has shown that noncustodial parents will identify a lower amount of child support obligation as fair, while custodial parents will identify a much higher amount as fair. Reducing the amount of a child support obligation increases the payer’s perception of fairness.

Numerous studies have reported a strong relationship between a noncustodial parent’s ability to pay and the resultant compliance in actually making child support payments (Bartfeld): Fathers with higher incomes comply better with child support. Related research has shown that a decline in men’s earnings, whether from wage decreases, unemployment, or inflation, is an important factor in noncustodial fathers paying less than their full child support obligations (Case, Lin, and McLanahan).

Need for a Child Support Payment Tax Incentive

In light of this research, a tax incentive would enhance child support payment compliance under a consensus-based approach. This approach would increase the noncustodial spouse’s ability to pay by reducing the after-tax cost of child support while improving perceptions of societal and legal process fairness. Noncustodial parents would likely perceive that a tax benefit designed specifically for them is a signal of empathy from government and society that low- and middle-income child support payers often need help to meet their payment obligations. Use of the consensus-based approach should further produce positive (rather than negative) attitudes among child support payers, as well as create overall positive societal consequences.

A child support tax incentive would also increase the taxation equality between custodial and noncustodial parents. Custodial parents receive several tax benefits that are generally not available to noncustodial parents, especially low-income parents who cannot afford expert tax advice. These include the dependency exemption for children, the child tax credit, and the earned income tax credit (EITC).

The EITC is particularly important to consider. The EITC was created in 1975—the same year that Congress established federal child support enforcement initiatives. The EITC provides an incentive for low-income custodial parents to work, but it does not provide an incentive for low-income noncustodial parents to work. A large body of research indicates an association between the EITC and an increase in the employment rates of, and hours worked by, “single mothers” (i.e., the custodial parent). A child support tax benefit would provide a work incentive for the other parent—the noncustodial parent—as well as provide some parity in tax treatment. Because the EITC requires that a taxpayer actually work in order to receive the credit, a child support tax incentive could require that the noncustodial parent actually pay the obligation to receive the tax benefit.

Several states offer an EITC (see Patrick E. Doles, Michael W. Matt, and Bradley T. Owens, “A Student Perspective on the IRS’s VITA Program,” The CPA Journal, February 2005). For 2006 tax returns, New York State initiated a noncustodial parent EITC for low-income taxpayers who are current on child support obligations; however, the credit is based on earned income—not on support payments. The noncustodial parent EITC is not an additional credit, but an alternative to the regular EITC.

A tax incentive for child support payments would produce a win/win situation: 1) Noncustodial parents would be encouraged to make child support payments because the tax incentive would reduce the after-tax cost of such payments while also enhancing payer perceptions of societal fairness; 2) custodial parents would receive support payments to decrease household financial insecurity; 3) children would benefit from funds received by the custodial parent for their welfare, thus decreasing poverty; and 4) the time and money spent by society and the legal system in enforcing and collecting child support (e.g., courts, attorneys, incarceration costs, collectors) would be reduced.

Current Tax Law Treatment of Child Support Payments

Typically, when parents divorce, two financial issues immediately surface for the noncustodial parent: child support and alimony. The intent of funds for child support from noncustodial parents is to provide for the welfare of children, which is a legal requirement of parents irrespective of their marital status, while alimony provides payments to support a former spouse. Noncustodial parents currently do not receive any federal tax benefits pertaining to their ongoing financial support of children. Alimony payments to former spouses are deductible under IRC sections 62(a)(10) and 215. A divorced spouse who receives alimony is taxed on this income per IRC section 71(a), but is not taxed on child support payments received from the noncustodial parent, according to section 71(c). The custodial parent can typically claim a dependency exemption per section 152(e)(1), even if the custodial parent does not provide more than 50% of the child’s support. [The noncustodial parent may be able to claim the dependency exemption if the custodial parent waives the right pursuant to section 152(e)(2).] The custodial parent also generally can claim the section 24 child tax credit of $1,000 and the earned income tax credit on wage income (but not on alimony receipts) under section 32.

Three Alternatives for Child Support Tax Incentive

These are three general options that the U.S. Congress could use to provide a child support tax incentive to reduce noncustodial parent after-tax costs while also promoting perceived societal fairness:

Deduction “from” AGI. A new itemized deduction could be created to provide a tax incentive for noncustodial parents to make child support payments. Congress could create a child support deduction using one or more of the following alternatives to target middle- and low-income taxpayers: 1) Child support payments could be claimed in total on Schedule A; and 2) an adjusted gross income (AGI) ceiling could be established to limit the total claimed in one year, similar to the current tax law treatment of charitable deductions (IRC section 170); and 3) an AGI floor could be implemented, such as the 2% of AGI floor associated with miscellaneous itemized deductions (IRC section 67).

The underlying problem with allowing child support payments to be treated as itemized deductions is that the provision would be designed to help the lowest-income taxpayers, who typically lack sufficient itemized deductions to exceed the standard deduction. The IRS Statistics of Income data (see www.irs.gov) for 2003 (the most recent year available) indicate that only 33% of individual tax returns claimed itemized deductions, with 80% of itemizers reporting AGIs over $50,000. Thus, an itemized deduction for child support payments would likely assist only wealthier taxpayers who itemize, and who are more likely to meet their support obligation without such an incentive. Even if poorer noncustodial parents could itemize child support payments on Schedule A, they would likely lose much of the incremental benefit, because any excess over the standard deduction would likely be quite limited.

Deduction “for” AGI. Another, more viable alternative would be to allow payers of child support to claim deductions “above the line,” often referred to as deductions “for” AGI. These deductions would be similar to those listed in IRC section 62 (e.g., interest expense on educational loans, moving expenses, alimony payments). Congress would probably place a cap on the annual amount of child support payments, possibly in the range of $3,000 to $8,000 in order to target the benefit specifically to low- and middle-income taxpayers. A cap could be structured on a per-child basis so that there would not be less incentive to provide support for multiple children.

As an alternative to, or in addition to, capping the deduction, Congress could use AGI phaseouts to further target the deduction to low- and middle-income taxpayers. Caps and phaseouts would minimize the cost of the tax law change for the child support deduction. Because all taxpayers are entitled to this type of deduction, deductions “for” AGI are more equitable than itemized deductions for most low-income payers of child support.

Tax credit. Another possible tax benefit alternative for child support payments would be to provide some form of a tax credit. Again, limits on the credit would need to be structured so that they apply on a per-child basis so as not to penalize noncustodial parents supporting multiple children. If this approach were implemented, Congress would clearly need to provide some sort of limit, because it is impractical to allow the entire payment as a credit against income tax. This limit cap could be a total dollar amount, $2,000 to $3,000 per child, for example, or based on a percentage of total child support.

As discussed above, the EITC has been shown to be remarkably successful in increasing the labor force participation of custodial parents. A particularly effective feature of the EITC is the structure of a phase-in, plateau, and phaseout range for calculating the amount of the credit (Susan B. Anders, “An Empirical Analysis of the Effect of the Earned Income Tax Credit on Work Effort,” Advances in Taxation, 2002). To target the benefit to low- and middle-income taxpayers, a child support tax credit could be structured similar to the EITC with a phase-in range offering the highest percentage of total child support, a plateau range with a flat amount (the cap), and a phaseout range with a decreasing percentage.

Additional Considerations Related to Child Support Tax Incentives

In designing a tax incentive for child support payments, Congress should consider additional issues:

Do not tax the custodial parent. Although this article proposes that the noncustodial parent obtain a tax incentive for child support payments, Congress should not dictate the usual tax symmetry (e.g., as found in alimony) where the custodial recipient of child support funds is taxed under IRC section 61. Although this nontaxability would be an unusual state of affairs in the tax code, precedent exists where this does occur (e.g., corporations can deduct certain employee fringe benefits, yet these benefits are tax-free to recipients in accordance with IRC section 132). Also, an argument can be made that the custodial parent is only an agent for the receipt of child support on behalf of the child.

Consider phaseouts for tax incentives. Currently, many tax incentives have associated phaseouts to target benefits to low- and middle-income taxpayers. For example, IRC section 219 outlines deduction phaseouts for traditional IRAs, while IRC section 68 provides an overall limitation on itemized deductions, often referred to as the “phantom tax.” These phaseout provisions limit the potential loss of tax revenues, while targeting tax breaks to the segment of society that most likely needs them. A disadvantage to phaseouts, however, is that they further complicate the tax code.

Tax incentives will trigger manipulation. Probably one of the strongest arguments against providing a tax benefit for child support payments is the likelihood that negative societal externalities will occur when some taxpayers purposely manipulate their personal affairs to claim the tax incentives for child support. To illustrate, such tax incentives may encourage taxpayers to divorce (or never marry in the first place) to obtain the tax benefits of child support payments. Child support research has shown that birth rates among single women, especially those with less education, actually decline with increased child support enforcement, because men have an increased disincentive to have children out of wedlock (Anna Aizer and Sara McLanahan, “The Impact of Child Support Enforcement on Fertility, Parental Investments, and Child Well-Being,” The Journal of Human Resources, 2006).

Taxpayers could also attempt to claim tax benefits fraudulently. Similar compliance problems exist with regard to the EITC, but the success of that credit in encouraging work has led Congress to keep the credit while delegating increased enforcement efforts to the IRS. Taxpayers who claim a child support deduction or credit should be required to report the Social Security numbers of the supported child and custodial parent, which can be matched by computer. The IRS has already been involved to a certain extent in the child support transfer scenario, as it redirects federal tax refunds to satisfy the overdue obligation under the Treasury Offset Program.

Implications of an Incentive

Congress should consider creating a tax incentive for the payment of child support consistent with the consensus-based approach to modify compliance behavior. A deduction “for” AGI or a tax credit would more effectively benefit low- and middle-income taxpayers than would a new itemized deduction. This tax benefit would reduce the after-tax cost of making child support payments, which would correspondingly increase the noncustodial parent’s ability to pay. A child support tax incentive would encourage compliance behavior as well as enhance the perceived societal and process fairness to payers of child support. Increased compliance would increase the amount of child support paid to the custodial parent and, therefore, lessen the financial insecurity, hardship, and potential poverty for both the recipient parent and the child. This positive effect would also reduce the negative consequences to society, including the burden currently placed on the legal system for the collection of child support in arrears. Although a tax incentive for child support would reduce tax revenues collected by the federal government, it is likely that these tax costs would be more than offset by a decrease in the societal costs that result from nonpayment of child support.

While a tax incentive to pay child support would help mitigate a societal problem that has existed for four decades, this tax policy initiative will not completely fix this damaged state of affairs. The arguments offered here are economics-based and seek to redirect policy strategies where government may assist in a scenario that involves many complex interacting variables. Indeed, the solution to the child support compliance problem is as much psychological, cultural, and demographic as it is economic.

©2009 The New York State Society of CPAs. Legal Notices