Tax Credit Scholarships: “Neovoucher” Profiteering Disguised as Philanthropy
In October 2016, Carl Davis of the Institute on Taxation and Economic Policy published a paper entitled, “State Tax Subsidies for K12 Private Education.” Below is Davis’ introduction:
One of the most important functions of government is to maintain a high-quality public education system. In many states, however, this objective is being undermined by tax credits and deductions that redirect public dollars for K-12 education toward private schools. Twenty states currently divert a total of over $1 billion per year toward private schools via special tax credits and deductions. These tax subsidies are essentially backdoor voucher programs, or “neovouchers,” as they use the tax code to provide what amount to private school vouchers even when traditional voucher programs are unpopular with the public or outright unconstitutional.
Because of the ways that state and federal tax law interact, the subsidies offered in ten of these states turn the concept of a charitable “donation” on its head by offering upper-income taxpayers a risk-free profit on contributions they make to fund private school scholarships. In these cases, even taxpayers who would not ordinarily be interested in contributing to private schools may find the incentive too strong to ignore.
Some states have seen an entire year’s allotment of tax credits claimed within days, or even hours, of being made available as wealthy taxpayers seek to capture their share of the profits associated with convoluted “neovoucher” systems.
In effect, states that have encountered political or constitutional obstacles to spending public dollars on private schools have instead set up a system that allows wealthy taxpayers to enjoy a profit by facilitating such spending on the state’s behalf.
This report explains the workings, and problems, with state-level tax subsidies for private K-12 education. It also discusses how the Internal Revenue Service (IRS) has exacerbated some of these problems by allowing taxpayers to claim federal charitable deductions even on private school contributions that were not truly charitable in nature.
Finally, an appendix to this report provides additional detail on the specific K-12 private school tax subsidies made available by each state. [Additional paragraph breaks added.]
Indeed, the heart of the scam factor behind the education tax credit appears to be in the seeming ability of donors to receive tax breaks in excess of donations. From the section of Davis’ paper entitled, “Subsidies Run Amok: Profiting from Scholarship ‘Donations'”:
In 2011, the IRS issued a memo indicating that taxpayers can claim a federal charitable deduction for private school scholarship donations even when those donations are also subsidized with a state tax credit. While the memo states that it “may not be used or cited as precedent,” scholarship organizations in over dozen states have been advising their donors that their contributions are eligible for a federal tax deduction in addition to a state tax credit.
For some high-income taxpayers, this dual benefit can turn a scholarship “donation” into a profit-generating scheme where the total tax cut received significantly exceeds the size of the original donation. It should therefore come as little surprise that in some states, the entire allotment of available credits is often claimed just hours after state tax officials begin accepting applications. …
Many scholarship organizations have realized that the profit-generating opportunities outlined above may appeal to donors that would not otherwise be interested in giving to private schools. One organization based in Georgia, for example, brags to potential donors that “you will end with more money than when you started.” Similarly, a tax lawyer in Alabama notes on her firm’s website that for taxpayers subject to the AMT, “donating” will actually “put money in your pocket.” …
Wealthy taxpayers appear to have taken notice. In Georgia, the state’s entire allotment of $58 million in scholarship credits was claimed in a single day on January 1, 2016. Later in the year, the same occurred within a matter of hours with regard to $67 million of credits in Arizona and $763,550 in credits in Rhode Island. [Additional paragraph break added.]
Finally, among Davis’ conclusions is the following:
…Upper-income families that are able to exploit complex interactions between state and federal tax law can sometimes use these backdoor subsidies to generate a profit for themselves. This is made possible largely because the IRS currently allows taxpayers to claim a charitable deduction for private school contributions even when those contributions were fully reimbursed by the state and were therefore not truly charitable in nature.
“Not truly charitable,” indeed.
On April 04, 2017, Jennifer Berkshire and co-host Jack Schneider featured Davis in a 34-minute, Have You Heard podcast.
Below are excerpts from a 3-minute section of the interview (around minute 9:00 to 12:00):
JB: So, Carl, you did a study last year, and suddenly, you’ve gotten a lot of attention because it turns out that you’re really one of the few people who has been keeping an eye on how tax credit scholarships work and where the potential for abuse lies at both the state and federal level, and, in some states, how the two different tax credits work together to make particularly generous donors a pile of money.
CD: Yeah, I think these tax credits have received more attention as education policies than as tax policies. I don’t want to speak for the whole tax policy community, but I don’t think…
I don’t think we in truth have been paying enough attention to what’s been going on here. At the state level, we now have 17 states that are offering very, very generous tax credits for donors that give money to private school scholarship funds in order to help students attend private, K12 schools. And these credits, in some cases, they range up to 100 percent of the amount donated, which is just a highly unusual feature to have as a tax law. …
When you’re reimbursing taxpayers for 100 percent donated, there doesn’t need to be any generosity at all involved on the taxpayer’s part. And in fact, what we’re finding is that in some cases, certain taxpayers are in a situation where they are able to game the system and are being advised by their accountants to claim a state tax credit and a federal tax deduction on the same donation and actually turn a profit for their so-called generosity. At this point, I’m not even sure if the word “charitable donation” applies. If you’re turning a profit on the deal, there’s nothing philanthropic going on. …
The underlying motivation here is that states want to spend public money on private schools, and a lot of times that can’t do that, either for political reasons… or for constitutional reasons…. So, what they’ve done is set up a more elaborate tax credit system that allows them to accomplish the same goal but that lets them get around the political hurdles or constitutional hurdles. So, what happens is they given these very generous incentives….
To further investigate the subtleties in education tax credits, and to view specific state information, be sure to read Davis’ paper.
For firmer grounding in educational tax credits, including associated Blaine Amendment history, be sure to read this Blaine Amendment post and Davis’ paper, and listen to the entire Have You Heard podcast.