On July 1st, the IRS plans to launch a portal that will enable parents to claim the new, expanded Child Tax Credit. Low- and moderate-income families with children stand to receive an annual total of $3,000 per child aged six to 17 and $3,600 per child under six. Roughly 83 million children live in households that stand to benefit from the expanded credits.
Unlike traditional tax credits, which are awarded as a lump sum at tax time, these Child Tax Credit payments will, if the rollout goes as planned, be sent to families monthly between July and December, unless claimants use the IRS portal to opt out of monthly distribution.
Will these monthly payments increase savings rates and balances among the parents who receive them? Experts say that remains to be seen.
What we know about how lump sum payments drive savings behavior
To understand the likely impact on consumers of the upcoming child tax credit payments, it’s helpful to compare the payments to other cash infusions low- and moderate-income families receive.
Through the Earned Income Tax Credit (EITC), the country’s largest anti-poverty program, working families receive lump sum payments at tax time that total more than $60 billion each year, with average payments per filer of $2,476 in the 2019 tax year. EITC recipients tend to use these annual payments to pay down debt and to spend on necessities such as food or housing, making tax time an important moment for households that need to catch up on financial obligations or make purchases they had previously deferred for lack of funds.
The recent rounds of Economic Impact Payments (stimulus checks) have also made clear the power of lump-sum cash infusions, which combined with unemployment assistance, SNAP benefits, and other social supports, to reduce material hardship and blunt the economic impact of the pandemic.
Researchers found that lower-income recipients were more likely to use the Economic Impact Payments to pay down debt, while more moderate-income families had higher rates of saving their stimulus payments, a dynamic that may play out with the Child Tax Credit payments, too.
Additional analysis from BlackRock’s Emergency Savings Initiative showed that Economic Impact Payments—along with the high salience of the importance of savings during the pandemic and a shift in spending patterns during 2020—all led some low-income individuals to start saving for the first time last year. However, savings gains from these payments may have vanished as families have spent down savings to cover other expenses,
Why the expanded Child Tax Credit could be different
If lump sum payments are a powerful tool for promoting financial health, why is the expanded Child Tax Credit designed to go out in monthly installments?
Monthly payments can help recipients engage in what’s called consumption smoothing—making up for the peaks and valleys in spending and income. Rather than saving up to make several purchases (or pay down debt and catch up with bills) when receiving a tax refund, families can more easily manage their finances month to month. For families with ongoing liquidity challenges, the monthly payments may not lead to a static high savings balance, but they can assist with cash flow management and keep families from taking on high-cost debt, a critical role that emergency savings also play in supporting financial health.
One potential complicating factor is the rollout of the credits themselves. Unlike the Economic Impact Payments, which were disbursed to many Americans who do not file taxes, the Child Tax Credit payments rely on families filing their tax returns, either through traditional means or via a simplified online portal that the IRS plans to launch, putting the IRS in the role of administering this critical new benefit.
The Earned Income Tax Credit, though it has proven to be a successful tool to reduce poverty, still only reaches roughly 80% of eligible recipients, and some fear that the expanded Child Tax Credit will similarly fall short of reaching all eligible households.
“Our creaky tax system is the primary barrier to success for the expanded Child Tax Credit” notes Dan Murphy, Policy Manager at the Financial Health Network. “The key will be whether we can find a way to ensure that as many eligible recipients as possible receive their Child Tax Credit as quickly as possible. Delays are the primary danger, and would risk making the Child Tax Credit a byword for government failure.”
What researchers and practitioners should keep an eye on
Researchers will be watching the impact of the payments on households, monitoring survey responses and transactional data to see how households use the funds, and how the payments impact families’ financial wellbeing.
The 2020 U.S. Financial Health Pulse found that more than two-thirds of people in America (167 million people) are not Financially Healthy (they are either Financially Vulnerable or Financially Coping), and financial health disparities have widened by race and income, and persisted across gender.
“It will be critical to understand whether these payments allow households to build up savings to cover unexpected expenses or lost income,” says Murphy.
But savings outcomes aren’t the only financial health outcomes worth monitoring. Researchers can also look at whether receipt of the monthly payments is associated with other wellbeing indicators, such as less debt or less stress.
Tim Lucas, Director of Research at SaverLife, a national nonprofit fintech with a mission to create prosperity for working families, expects the tax credits to have a measurable positive impact.
“According to SaverLife member data, nothing does more to promote financial stability for low-income families than tax credits and stimulus payments,” Lucas says. “They help people reduce medical and credit card debt, catch up on utility bills, and boost savings balances that help guard against frequent income and expense shocks. The expanded Child Tax Credit should provide much needed breathing room for families still reeling from the economic fallout of the COVID-19 pandemic.”
Already, practitioners are planning how to message the payments to the clients they serve and working to encourage eligible individuals to file their taxes and claim their credits. For those who receive the payments, practitioners have the opportunity to message savings where appropriate to a family’s financial circumstances.
Financial Health Network’s Director of Behavioral Economics Heidi Johnson says the same strategies that have been used to promote tax-time savings for the EITC could help more families save their Child Tax Credit payments.
“Practitioners such as financial coaches and volunteer tax preparers should invite people to plan for how they’re going to use the money from the monthly payments. Making a plan to save money is associated with follow-through if people have really thought about what they want to do with the money,” Johnson says. “If savings is a component of parents’ financial goals, planning ahead for how they will use the Child Tax Credit payments will help them work towards that goal.”
Recipients of the Child Tax Credit who have a little more slack in their budget and lower debt levels may be good candidates for child savings accounts and 529 college savings accounts, added Johnson.
As the country continues to recover from the economic impacts of the COVID-19 crisis, expanded Child Tax Credits will play a role in supporting families and enhancing financial wellbeing. Analysts estimate that the credits will reduce the child poverty rate by 45% (from 14% to 7.5%). The expanded credit could become permanent if this year’s rollout is successful and the Biden administration succeeds in passing its American Families Plan, so the stakes are high.
BlackRock’s Emergency Savings Initiative
BlackRock announced a $50 million commitment to help millions of people living on low to moderate incomes gain access to and increase usage of proven savings strategies and tools – ultimately helping them establish an important safety net. The size and scale of the savings problem requires the knowledge and expertise of established industry experts that are recognized leaders in savings research and interventions on an individual and corporate level. Led by its Social Impact team, BlackRock is partnering with innovative industry experts Common Cents Lab, Commonwealth, and the Financial Health Network to give the initiative a comprehensive and multilayered approach to address the savings crisis. Partners including UPS, Mastercard, MX, and Self Financial have joined BlackRock’s Emergency Savings Initiative to help their employees and customers take the essential first step toward long-term financial well-being.