Even as the economy slowed in the third quarter as the delta variant took hold, that slowdown would have been far worse if not for the enhanced child tax credit that was introduced on July 15.
By our estimate, the enhanced child tax credit contributed up to 2.5 percentage points to real GDP growth in the third quarter.
By our estimate, the enhanced child tax credit, which provided direct payments to about 35 million families with children, contributed up to 2.5 percentage points to real gross domestic product growth in the third quarter, outstripping the overall growth of 2% reported recently by the Bureau of Economic Analysis,
Now, by having such a significant impact, the tax credit provides a potential template to policymakers for enhancing overall consumption, improving food security and alleviating duress to households during periods of supply disruptions that we expect to run though the second half of next year.
A big reason for its effectiveness was the way it was set up: The child tax credit sent direct payments to mostly lower-income families who often have the highest marginal propensity to consume. Those payments, in turn, were quickly spent on essentials like food, rent, clothing and utilities, which helped cushion the impact of the supply shock that the economy is absorbing.
The program was a life saver for many households against the unexpected resurgence of the delta variant. And the timing was fortuitous: The program’s payments began just as the fiscal impact of the American Rescue Act of 2021 faded and as pandemic-related unemployment benefit programs expired in early September.
But the program may not last. The enhanced credit is set to expire next year, although the proposed $1.75 trillion government spending plan would extend it for one more year.
If anything, the promising early results of the program make a strong argument for continuing a policy that has the potential to significantly reduce child poverty and food insecurity. If policymakers extend the program or make it permanent, the enhanced child tax credit is positioned to be one of the foundations of a reshaped American safety net.
Effect on spending
The impact of the program on spending was immediate from July 21 to September 27, according to weekly data from the Census Bureau’s Household Pulse Survey.
More than half of the families that received the payments spent their extra income on food that helped to reduce food insecurity, while one-third of them spent on school expenses on time for the start of the school year.
About 30% reported spending the money on clothing and utilities, while 28% spent on housing that included rent and mortgage payments.
In total, the program raised household incomes in the third quarter by $218.9 billion from $34.4 billion in the previous quarter on a seasonally adjusted annual rate, according to the Bureau of Economic Analysis.
The policy not only fueled consumer spending, but it also had a multiplier effect across the economy, boosting the overall spending level.
A recent study on the marginal propensity to consume during the pandemic by the Federal Reserve Bank of Chicago found that “stimulus recipients who live paycheck-to-paycheck spent 60% of the stimulus payment within two weeks, while recipients who save much of their monthly income spent only 24% of the stimulus payment within two weeks.”
Using the upper bound of the 60% figure, we estimate that the overall impact of the child tax credit on nominal GDP could be up to an 8.1% increase, or a 2.5% increase on real GDP after adjusting for inflation.
Such an increase, in retrospect, helped to offset the economic damage from the delta variant’s surge, supply-chain disruptions and inflation on spending in the third quarter, which was seen early on in July as real personal spending declined by 0.3%. Real spending then rebounded in August and September, rising by 0.6% and 0.27%, respectively.
Effect on poverty
The program also helped to target many of the demographic subgroups that were hardest hit by the pandemic.
According to researchers from Columbia University, the enhanced child tax credit could reduce child poverty by about 45% with the biggest declines taking place among Native American, Hispanic and non-Hispanic Black children.
At the same time, non-Hispanic Black and Hispanic families used the tax payments in much higher proportions than non-Hispanic white families for school expenses, which was one of the main goals of the program.
The program also helped low-income families pay for necessities and debts more than higher-income families. About 84% of households with less than $50,000 in annual income reported that they either mostly spent their extra income from the program or paid off existing debts, according to the Household Pulse Survey.
This percentage was significantly higher than the percentages for household groups with income from $50,000 to $100,000 and income above $100,000, which were 73% and 53% respectively, as higher-income families are often able to save more.
The takeaway
The enhanced child tax credit has been a game-changer for American families and the economy, especially in the third quarter of the year. This happened not only because of the significant increase in total payment size but also because of its policy innovation that helps to send advanced and direct checks to families before the next tax filing season.
If the program gains new life, it would continue to have a profound economic and social impact both now and over the long term on American families that are the foundation of the economy.
