Over the last 40 years, working-age Americans have struggled amid increased income volatility. What’s more, working-class households and families with children are more likely to experience negative income shocks. Concerning families in particular, a new study finds that “earnings churn stemming from inconsistent employment and/or work hours is one of the leading causes of family income variability.”

Many factors, including cultural and economic, contribute to family stability. In recent years, there has been growing recognition that family stability and income stability go hand in hand. To facilitate family stability, policies that provide some relief from income volatility–particularly for working-class families–are helpful.The tax system has increasingly played a role in mitigating income instability among middle-class families, but has been markedly less responsive to working-class families relative to traditional social programs. 

An innovative provision in the Tax Relief for American Families and Workers Act of 2024 could help mitigate the negative impact of earnings volatility for working-class families by giving them more flexibility in how they calculate their child tax credit. 

What does the “lookback” provision do?

The Smith-Wyden tax deal makes several changes to the child tax credit (see our explainer here), including a “lookback” provision that changes how families can calculate the value of their child tax credit. 

Under current law, families must use their current year’s earnings to determine how much credit they can receive during tax time (e.g., the child tax credit portion of your 2023 tax refund is based on how much you earned in 2023). Under the proposed change, families can choose between their current or previous year’s earnings to determine how much they can receive during tax time (e.g., the child tax credit portion of your 2023 tax refund is based on how much you earned in either 2023 or 2022). Under the proposed reform, for example, a worker whose annual earnings drop from $15,000 in one year to $10,000 the following because his hours were cut could still claim the maximum refundable portion of the credit by “looking back” to his previous year’s earnings and using that to calculate the credit. 

The lookback provision can be considered a form of wage insurance to help buffer against unforeseen interruptions in a household’s earning power. This is why Congress has allowed similar one-year lookbacks on several occasions in the face of natural disasters and during COVID – as a recognition that these things are out of parents’ control but that they still rely on these tax credits to smooth out their income and continue to support their childrens’ needs.

Acute obstacles to maximizing annual earnings

Natural disasters are the most salient force interrupting household earning power. Still,  there are several mundane forces that can prevent families from earning enough to receive the full credit in any given year. These include: cutbacks in available hours, family emergencies, and layoffs leading to brief spells of unemployment. 

First, many workers who prefer to work full-time face cutbacks in hours from their employers. Many jobs, particularly in the service sector, will vary how many hours workers can work in a given month or season based on varied demand. Almost half of all hourly employees report having little or no input into the number of hours they work, leading to fluctuations in hours worked, especially among workers of childbearing age. 

Tighter labor markets tend to reduce volatility in hours worked, but employers tend to pass on the cost of volatile demand to workers when economic times get tough. A reduction in hours over a year can lead to lower annual earnings that may impact families’ access to the child tax credit at tax time.

Second, many workers face unexpected layoffs that temporarily reduce earning power. Plant closings, mass layoffs, and recessionary periods are the most salient examples, but even the mundane churn of labor markets leads some workers with children to lose their jobs as firms restructure and adjust to changing economic conditions in their industry. 

Many workers have access to Unemployment Insurance to help them weather the storm but most states use a strict wage replacement rate that does not account for whether workers have dependent spouses or children. For example, if two workers earning similar amounts are both laid off and claim unemployment benefits, the single childless worker receives the same amount as the married worker with two children. This partial wage replacement is helpful, but the temporary loss of earnings means a parent’s annual earnings may drop to a point where they lose some or most of their child tax credit at tax time. 

Lastly, some workers face cutbacks in hours or temporary leaves because of family emergencies. The Family and Medical Leave Act guarantees workers who have accrued enough hours the right to take time off for the birth of a new child or to care for a spouse, child, or parent with a serious health condition. In many cases, workers must take unpaid leave. This is particularly true for lower-wage workers who are least likely to have access to employer-provided paid leave options. New parents taking time off with their newborn or parents taking time off to care for an elderly parent may face lower annual earnings that may impact their child tax credit at tax time.  

In each of these cases, the proposed lookback provision would ensure that workers with children do not lose access to the full credit during acute interruptions in earning power in any given year. 

Will it foster dependency?

Some policymakers have expressed concern that the lookback provision may reduce labor force participation and lead to long-term dependency in some cases. This is potentially true in the case of second earners, who may have wanted to spend more time with children and will have more room to reduce work hours because of another provision phasing the credit in faster, but the strict one-year lookback period safeguards against dependency. 

Parents cannot drop out of the labor force altogether and continue to receive the credit each year. The idea of some parents gaming the system by jumping into and out of work every other year defies common sense and what we know about the hiring process. Employers are highly suspicious of gaps in full-time employment. Evidence tells us that, when they apply for full time jobs, employers view part-time workers as having distracting obligations outside of work while viewing unemployed workers as raising concerns about personality and soft skills. Workers are well aware of these pitfalls, which is why they try to avoid part-time work and gaps in employment in the first place. 

Limiting the lookback to one year ensures it is built for acute interruptions to earning power like the aforementioned–not long-term dependency.

Income stability bolsters family security

The proposed lookback provision in the Tax Relief for American Families and Workers Act has been a major source of misunderstanding in recent weeks. Policymakers concerned about building a foundation for stable families should welcome it as an innovative reform to reduce some of the economic volatility that threatens family flourishing.