As the One Big Beautiful Bill Act is implemented and its economic impact becomes reality, we can expect the good, the bad, and the ugly. On the bright side, there are several provisions that are intended to help parents and children, with the goal of providing more affordable, easily accessible childcare.
Now it is time for states to do their part.
The OBBBA has three key provisions on this front: 1) Expands tax credits to employers providing childcare and family medical leave; 2) increases the maximum annual tax-free contributions dependent care flexible spending accounts, which parents can use for daycare, and 3) raises the amount of general childcare expenses that are covered by the Child and Dependent Care Tax Credit (CDCTC).
Because relatively few companies provide care services themselves, the greatest splash will likely come in the expansion of the CDCTC. This non-refundable credit program has a new cap of $1,050 for a single adult or $2,100 for those filing jointly, approximately double what it had been since 2001. Depending on income and filing status, eligible expenses range from 20 to 50 percent of childcare costs. Importantly, the setting of care does not matter for the tax credit—childcare payments to neighbors and nannies count too.
Who (and where) will benefit the most from changes to the CDCTC? A couple thousand dollars in the form of a tax credit is a massive benefit to some and a laughable amount to others. The Childcare Regulation Index allows us to better predict the relative winners and losers of the OBBBA’s family-related measures. Unsurprisingly, parents who get the most out of the childcare tax credits are those who live in states where childcare is less expensive.
While there are a myriad of factors contributing to supply and demand for childcare, our analysis of the states’ childcare licensing regulations shows that red tape is a major contributor. Regulations represent barriers to entry for new businesses, limit the pool of qualified staff members, and diminish the range of flexible childcare options. If, like Vermont, your state requires preschool teachers to have a bachelor’s degree, a $2,100 tax credit doesn’t offset a month’s expenses.
In Louisiana, the cost of center-based care for an infant is about $10,000 annually (9.1 percent of median income). In Massachusetts, the same services cost roughly $24,000 annually (14.4 percent of median income). Louisiana and Massachusetts are at opposite ends of the Childcare Regulation Index—they represent the wide variety of state-level standards governing child-to-staff ratios, maximum group sizes, minimum educational requirements for center directors and staff, and more. Whereas the maximum CDCTC credit amounts to 20 percent of annual childcare costs in Louisiana, it covers less than nine percent of annual childcare costs in Massachusetts (for those using center-based care for infants).
Tax credits are one way to help families in a financially strained season of life. Rather than direct transfers in the form of a “baby bonus,” credits help families keep more of their money when tax season comes around. However, the state regulatory regime surrounding childcare severely limits how far these savings go.
Matching with trusted childcare providers is an important task for parents, and doing so successfully can help enable families to grow. Recent research by the Archbridge Institute affiliates suggests that less red tape on childcare is one element of economic freedom that improves Americans’ ability to find work-family compatibility and achieve their family size goals. Childcare markets in economically free states are more dynamic in response to regional variation and parents’ needs.
If tax credits are meant to actually move the needle on decisions to enter the labor market or have another child, they would benefit from simultaneous efforts to widen the range of licensed childcare settings and increase competition to better meet parents’ needs.
Right now, expansions to the Child and Dependent Care Tax Credit feel like an indirect approach for addressing the childcare problem. States would be better served examining their own regulations, making sure that they are properly balancing child safety with affordability and accessibility.
Anna Claire Flowers is a PhD Fellow with the Mercatus Center at George Mason University and an instructor at the Catholic University of America. Edward Timmons, PhD is a senior fellow with the Archbridge Institute.
