«OVERTAXING THE WORKING FAMILY: UNCLE SAM AND THE CHILDCARE SQUEEZE Shannon Weeks McCormack* Today, many working parents are caught in a “childcare ...»
Fifth, the reformed deduction should not contain dollar limitations on the amount of expenses for which tax relief may be granted. As discussed in Section I.B, both §§ 21 and 129 impose dollar limitations on the amount of work-related childcare expenses that can be credited or excluded.228 As discussed in Section I.C, these limitation amounts represent a mere fraction of the costs most families will incur to provide full-time childcare, particularly if the family has multiple or young children. These childcare costs are merely one of many costs of earning income. But the Code does not impose dollar limitations on other costs of earning income—it does not insist that the car manufacturer use parts that are not too pricey or that the restaurateur be sufficiently frugal with his ingredients.
Still, one might want to impose some limits on working childcare costs since, unlike expenses for car parts or food ingredients, such costs have a consumptive whiff. To do so, an easy analogue is available in the tax laws
224. Code § 21(d) provides an “earned income limitation” that reads as follows:
(1) In general Except as otherwise provided in this subsection, the amount of the employment-related expenses incurred during any taxable year which may be taken into account under subsection (a) shall not exceed— (A) in the case of an individual who is not married at the close of such year, such individual’s earned income for such year, or (B) in the case of an individual who is married at the close of such year, the lesser of such individual’s earned income or the earned income of his spouse for such year.
I.R.C. § 21(d).
225. Id. § 21.
226. See Warner, supra note 6 (“Sylvia Ann Hewlett, an economist and the founding president of the Center for Talent Innovation in New York, surveyed thousands of women in 2004 and after the financial crisis in 2009. She has found that roughly a third of ‘highly qualified women’ leave their jobs to spend extended time at home.... Most of the women, Hewlett found, stayed home longer than they had hoped.”).
227. See supra note 73 and accompanying text.
228. See supra notes 57–64 and accompanying text.
Uncle Sam and the Childcare Squeeze 603 February 2016] providing deductions for business-related entertainment and meal expenses, which limit possible expenses to those that are not “lavish or extravagant.”229 As applied, this standard aims to curb only the most profligate spending. As explained by the IRS, An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.230 Disallowing a deduction for “lavish and extravagant” working childcare expenses seems perfectly appropriate, so long as the standard is applied in the same weak-toothed manner as it is in the meal and entertainment context. Just as attending to business at a deluxe restaurant is not a lavish or extravagant business expense,231 neither is it lavish or extravagant for a working parent to select an individual caregiver—as opposed to, for instance, using a cheaper day care—to tend to her children, particularly since this choice is sometimes a parent’s only feasible option.232 Nevertheless, this standard does provide some limitations on the expenses that taxpayers may incur with Uncle Sam’s help. If a company purchases its clients and employees seats in a luxury skybox, it may only deduct the costs of nonluxury seats.233 Similarly, if a parent sends her child to a fancy day camp in which professional golfers instruct children to perfect their drives, she may only deduct the nonlavish cost of, for instance, hiring an individual caregiver for the time spent at camp.
These five items provide a basic framework for aligning tax relief for working childcare expenses with the tax relief for other costs of earning income. No further limitations are needed or appropriate. But if lawmakers sought further limitations, Congress might consider a percentage limitation like that found in § 274. Under this provision, taxpayers may only deduct 50 percent of business-related meal and entertainment expenses.234 In this context, the idea that the government and taxpayer should split these expenses seems justifiable, if not slightly arbitrary. It can easily be argued, for instance, that while any particular taxpayer may have had business reasons for a meal, he nonetheless would have had to eat anyway. In other words, the substantial consumptive element is somewhat irrefutable in this context.
On the other hand, one cannot unequivocally say that a parent would have needed childcare regardless of her being at work—as discussed above, many families with stay-at-home parents forego regular childcare entirely.
Hence, there is little reason why the taxpayer should have to split the tax
savings with the government down the middle. As shown in Part III, meal and entertainment expenditures are far more consumptive than working childcare costs. Therefore, a more appropriate percentage limitation—if one were insisted on—would significantly exceed 50 percent and be somewhere close to 100 percent. If this change were implemented, Congress could ensure that no parents were aversely impacted by the change by allowing taxpayers to receive tax relief equal to the greater of the tax savings currently allowed under §§ 21 and 129 and a deduction for (say) 90 percent of actual working childcare expenses. Given the soaring costs of childcare and the severe limits of the current tax laws, the reformed deduction would likely be chosen in almost all cases.
Other tax laws allow taxpayers to deduct expenses up to a specified ceiling amount. For instance, taxpayers may deduct amounts contributed to charity but only to the extent that donations do not exceed 50 percent of the taxpayer’s income.235 This ceiling reflects the notion that, at some point, the taxpayer is diverting an exorbitantly large portion of his income away from the government’s reach. But these income caps are somewhat curious in that the cap is increased as income increases. Furthermore, the “lavish and extravagant” limitation suggested above would seem to capture costs exceeding this ceiling anyway. Nonetheless, if Congress wished to impose some additional limitation on the ability of families to reduce their taxable income to reflect working childcare expenses, an income cap could also be considered.
C. Potential Objections Hindering Future Reform
As with any suggested reform, potential objections might hinder its progress. The most obvious objection to the proposed reform is that too much revenue will be foregone. First, this objection is, at least in large part, fundamentally unsound. One does not ask whether it costs too much to allow the car manufacturer to deduct the costs of parts or the storeowner to deduct the costs of his employees. These adjustments are necessary to accurately calculate tax and it does not matter how much revenue is lost. To the extent that working childcare costs are nonconsumptive costs of earning income, foregone tax revenue is beside the point.236 Furthermore, while some revenue is sure to be lost if the proposed reforms are implemented, it may not be nearly as much as one initially thinks.
It is currently likely that many transactions occurring between parents and caregivers occur in cash, which increases the chance that the caregiver will
235. Id. § 170(b)(1)(A).
236. See Schaffer & Berman, supra note 133, at 536–37. It is particularly inappropriate to oppose childcare deductions on the grounds that the tax base should not be further eroded.
There is no doubt much to be said for the principle that the key to reform of the federal income tax is to reduce as far as possible all exclusions from gross income, and, more to the point here, all or most personal deductions. The resulting increase in the tax base would enable us to reduce tax rates, finance more government services or both. But the principle has nothing to do with the childcare deduction. Even those who insist on the most comprehensive of tax bases agree that the cost of generating income must be deductible.
Uncle Sam and the Childcare Squeeze 605 February 2016] underreport her income.237 Put more colloquially, parents often pay caregivers “under the table.” The current tax system, which provides tax relief for only a fraction of actual childcare costs, does little to prevent this.
Under the proposed reforms, however, parents would be able to obtain tax relief for most, if not all, of their working childcare costs. To do so, the tax laws might require parents to identify the caregivers paid, creating a mechanism for the IRS to check for underreporting.
Furthermore, if the proposed reforms were implemented, more nonprimary wage earners would be able to work. The importance of this should not be understated. Even small resume gaps can pose trouble for an individual re-entering the workforce.238 Therefore, making it affordable for parents to work through the early years of their children’s lives not only results in their earning additional (taxable) income in those years, but also preserves their ability to work, and, therefore, contribute to the tax base, for the remainder of their lives.
Another possible objection to the proposed reform is that the tax law should neither encourage nor discourage nonprimary wage earners to work.
There are a number of responses to this argument. Most importantly, to the extent that working childcare costs are a cost of earning income, the objection is once again fundamentally unsound. As discussed in Part II, a taxpayer must be able to deduct the costs of earning income in order to properly calculate her tax liability. Thus, allowing the toymaker (or gun maker) a deduction for costs of making toys (or guns) might be said to encourage toy (or gun) production. But whatever one thinks of toys (or guns) the tax law needs to allow the deduction to accurately capture income.
Similarly, to the extent providing a deduction for working childcare expenses is a necessary adjustment to reflect income, it does not matter whether one believes parents should be encouraged to work or that a woman’s place is in the home.
Next, the objection that the proposed reforms would encourage nonprimary wage earners to enter the workforce very arguably has it backward.
The current system should be viewed as causing behavioral distortions by discouraging nonprimary wage earners from working. Thus, the proposed reforms are better viewed as eliminating (and not causing) economic distortions. Put another way, the proposed reforms would equalize the treatment of a couple with children, one of whom provides childcare and therefore
237. See, e.g., Ilan Benshalom, Taxing Cash, 4 Colum. J. Tax L. 65, 67 (2012).
(“[I]ndividuals use [cash] to conceal certain transactions from their creditors and the state....
Cash allows income underreporting, which is the most significant source of tax evasion....”);
Kathleen DeLaney Thomas, Presumptive Collection: A Prospect Theory Approach to Increasing Small Business Tax Compliance, 67 Tax L. Rev. 111, 112 (2013) (“At one end of the spectrum are wage-earning employees, who demonstrate a near perfect rate of compliance [with income tax law]. At the other end of the spectrum are self-employed individuals earning business income, whose overall compliance rate is less than 50%. Tax evasion is a particular problem among self-employed individuals engaged in cash businesses, who are estimated to report a staggeringly low 19% of their income.” (footnotes omitted)).
238. See Warner, supra note 6.
606 Michigan Law Review [Vol. 114:559 incurs no working childcare costs, and a similarly situated working family that must incur these costs. Finally, couples increasingly need two incomes to meet their needs.239 Thus, the concern that the proposed reform would change a taxpayer’s decision as to whether to enter the workforce breaks down significantly, since parents increasingly have little choice in the matter.
It is also important when enacting a change in the tax laws to consider who can actually be expected to benefit from the reforms—that is, to ask whether the intended beneficiaries will truly enjoy the tax savings produced or whether the reformed tax laws will really end up helping an unintended group. If the tax law changes to allow families to deduct working childcare costs from their income, it will obviously produce great benefits to working parents. But some part of the tax savings produced by a reformed childcare deduction might inure to the benefit of childcare workers in the form of higher wages. Specifically, because the proposed reform would lower the post-tax cost of childcare, childcare workers might demand—and parents might be able to afford—an increase in salary. Lawmakers should welcome this possible secondary effect, as childcare workers have long fought to earn even a living wage.240
D. Protecting Progress: How to Prevent the Reoccurrence of Past Mistakes
As discussed in Section IV.A, the tax relief provided to working families through § 21’s childcare credit and § 129’s FSA exclusion may have become so inadequate due in large part to the Joint Committee on Taxation’s decision to place these provisions on its list of tax expenditures, signaling to Congress that they were “special” tax provisions that could be limited or repealed without compromising the accurate calculation of the income tax.
This characterization is inappropriate, however. The question of how one should separate tax expenditure provisions from other tax provisions has long been a subject of debate. Both the Joint Committee on Taxation, acting on behalf of Congress, and the Treasury Department have vacillated between two methodologies,241 indicating that even the actors statutorily required to identify tax expenditures understand the question to be murky.