(Originally published here.)
Parents are the world’s most important investors, making sure that the millions of children born every year become productive adults. Yet parents get shafted by a tax code that favors freeloaders without children.
People who don’t work depend on those who do: workers who generate profits for companies, rents on real estate and interest payments on bonds. Workers also pay the taxes that support the elderly in retirement. This is why parents tend to make everyone better off when they have children.
But raising children is expensive. People who don’t have kids avoid those costs while reaping many of the benefits. Perhaps the greatest injustice is that the childless can use the money they don’t spend in raising kids to pay for a comfortable retirement.
An example can help illustrate this. Imagine two 30-year-old couples with the same pretax income and otherwise comparable lifestyles. The difference is that one couple has twin children and the other has none.
The following chart shows how the net wealth of these two households changes over time:
The childless couple gets an advantage worth about $91,000 in today’s dollars. (I took the present value of the gap in net wealth at age 65 using a 5 percent discount rate.) And that generously assumes the childless won’t have advantages in the workplace that lead to faster wage growth over time. (To be fair, some childless couples pay property taxes, which go toward public schools they will never benefit from.)
So what should policy makers do? Reihan Salam at Slate proposes amuch larger child tax credit that would more than offset a broader increase in tax rates. There already is a tax credit for children, but it is small and wouldn’t be that helpful to our hypothetical family.
The advantage of a tax credit is that it could be claimed by the poor. Children who grow up in poverty tend to suffer from malnutrition and elevated stress hormones that permanently impair brain development, so money that makes it easier for low-income parents to provide a decent life for their children would make a lot of sense. The danger, however, is that some people would have more children than they could support just to claim the government benefits. Their children would be the real victims and may end up permanently dependent on support from the state for the rest of their lives. That wouldn’t exactly solve the problem of freeloaders.
Another option: Adjust the rates paid for payroll taxes, which go toward entitlements, according to the number of children you have. Those with more children would pay lower rates. Those with none would pay more to cover the difference between the benefits they will receive in the future and the taxes their non-existent children will fail to pay into the system. Older parents could get credits depending on how much their adult children pay in taxes.
Whatever policy makers do, they should think of the children.
Both partners in each couple work and each couple takes home about $70,000 after taxes. Each couple’s after-tax income grows by 4 percent a year on average until they retire at 65. Both households set aside 20 percent of their disposable income in an investment portfolio that generates an average return of 5 percent, which is reinvested each year. Then they collect Social Security benefits and draw down their savings enough to maintain their standard of living (after-tax income net of savings in their final year of work, including 3 percent growth in Social Security benefits and 4 percent growth in desired wages) until they run out of money. Let’s assume that child-care costs start out costing about $20,000 a year and that the cost of that care rises by 3 percent until they reach 18. Then the parents pay $70,000 a year for their two kids to go to college for four years. After 22 years, the parents finally get to take home as much as their childless peers until they retire.
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