The U.S. tax code contains many preferences that lower or eliminate the amount of taxes owed. Those preferences include deductions, exclusions, and tax credits, which can be either refundable or nonrefundable. Refundable tax credits differ from other preferences in a significant way: Whereas other preferences reduce the amount of taxes owed to the government, refundable credits can result in net payments from the government. Specifically, if the amount of a refundable tax credit exceeds a filer’s tax liability before that credit is applied, the government pays the excess to that person or business.
In the federal budget, the portion of refundable credits that reduces the amount of taxes owed is counted as a reduction in revenues, and the portion that exceeds people’s tax liabilities is treated as an outlay. Since 1975, when the first refundable tax credit took effect, outlays have accounted for between 50 percent and 80 percent of the annual budgetary costs of refundable tax credits.
The number and total costs of the refundable credits in the income tax system have grown considerably since 1975. The number of credits peaked at 11 in 2010 before dropping to 6 in 2013 (see Figure 1). Their total costs (that is, the reduction in revenues and the increase in outlays) reached a high of $238 billion in 2008. (That amount and other annual costs discussed in this report are expressed in 2013 dollars.) Those costs will drop to $149 billion in 2013, the Congressional Budget Office (CBO) estimates, mostly for the earned income tax credit (EITC) and the child tax credit. By 2018, three more credits will have expired, and the EITC and the child tax credit will have been scaled back.
Those cutbacks in refundable tax credits will be more than offset, however, by new health-related subsidies provided through the tax system. Starting in 2014, a new refundable tax credit will be available to some people for the purchase of health insurance through newly created exchanges. The cost of that credit will be about $110 billion by 2021, CBO and the staff of the Joint Committee on Taxation (JCT) project, bringing the total cost of refundable tax credits in that year to $213 billion— roughly the same as the costs in 2009 and 2010, even though the number of refundable tax credits will have fallen by more than half between 2010 and 2021.