Today, IWF released a chart comparing various child and parent tax credit proposals, which we hope will be a helpful resource for policymakers and others as we debate the merits of these proposals in the months ahead. There is one column in the chart that deserves some explanation: “Funding Mechanism.” Many readers might wonder why tax credits need to be funded—the government doesn’t pay you for a tax credit, the credit simply reduces your tax liability, right?

Not quite. To start with, the Child Tax Credit (“CTC”) is a “refundable” tax credit. Under President Biden’s American Families Plan, the CTC would be “fully” refundable, and Senator Hawley’s Parent Tax Credit would also be fully refundable. A fully refundable tax credit means that taxpayers who owe less in taxes than the amount of the credit will receive a “refund” equal to the difference between the amount of the credit and the taxes they owed.

Take, for example, a parent of two children under six years old who paid zero income tax (about 48% of Americans owe no federal income tax). Under the American Families Plan, that parent would be able to claim a CTC of $3,600 per child, and the government would send that parent a “refund” of $7,200. For these parents, the tax credit obviously does not function to reduce their tax liability; it’s essentially a new government benefit.

Moreover, even nonrefundable tax credits often function as government subsidies in disguise. Consider the Electric Vehicle Tax Credit, which ranges from $2,500 to $7,500 for purchases of qualifying vehicles. Any person can use this credit to decrease their tax liability by $2,500 to $7,500, depending on the amount of the credit. So a taxpayer who owes $10,000 in federal income taxes and receives a $7,500 credit would owe only $2,500 in taxes—making that taxpayer $7,500 richer. That’s effectively the same as charging the full $10,000 in taxes and sending the taxpayer a government subsidy of $7,500 to help purchase the car.

For many conservatives, the natural instinct is to approve of any reduction in tax burden. But conservatives should be wary of the use of tax credits as a backdoor to expanding government entitlements. A fully refundable Parent Tax Credit of $12,000, for example, is functionally the same as a $12,000 Universal Basic Income benefit for parents. Putting aside whether this is a good idea, at a minimum we should all agree that this new benefit would need to be funded.