Barone on Personal Exemptions and Tax Credits
By David Henderson
An Exemption is not a Credit
A steeply progressive income tax combined with generous dependent deductions ($500 originally, later raised to $600) played some unquantifiable part in stimulating the Baby Boom and family stability for a generation after the war.
Lee proposes a $2,500 child tax credit — less in real dollars than the postwar deduction — applied to both payroll and income taxes.
Those statements from columnist Michael Barone are both correct. But if you don’t think about them very carefully, you probably think that Barone is saying that the effect of the tax code in creating an incentive to have a kid is less now than it was in the years just after World War II. I think even Michael Barone thinks he’s saying that.
But it’s not true.
The reason is that the value to the taxpayer of a $2,500 tax credit is $2,500. The value to the taxpayer of an $X exemption is not $X but $X*t, where t is the marginal tax rate.
The postwar personal exemption from 1948 on was $600. The lowest marginal tax rate in 1948 was 20%. That makes the value of the exemption $600*0.2 = $120. Inflation adjust that to 2013 and the value is $1,162. So for people in the lowest brackets, the incentive to have a kid would be greater with a $2,500 credit than with the old $600 exemption.
Note: Barone addresses this issue in discussing Mike Lee’s proposal for what I called an anti-supply-side tax cut.