The Math Behind Ed Choice Tax Credit Fails Many Tests
February 21, 2017
Today in the House Education Committee legislators are hearing discussion of House Bill 162, a proposal to create a so-called Education Choice tax credit in Kentucky. This proposal does not target low- and moderate-income students as suggested; is expensive, taking resources away from public schools and other investments; and provides an excessively large credit under which some high-income individuals could actually make money.
Ed Choice Is Not Designed to Help Low- to Moderate-Income Families
House Bill 162 would create a 90 percent tax credit for individuals, businesses and banks who donate to Scholarship Granting Organizations (SGOs) that give financial assistance to families sending their kids to private schools.
Though proponents suggest it is a way to provide school choice to families who would otherwise not be able to afford it, the proposal does not target low- or even moderate-income families. The eligibility criteria makes scholarships available to families with income significantly higher than what typical Kentucky families make.
- Income eligibility for the scholarship is up to 200 percent of household income necessary for reduced-price meals. Reduced price meal eligibility is 185 percent of the federal poverty line (FPL) based on family size.
- For a family of four, multiplying the FPL of $24,600 by 185 percent, and then by 200 percent yields $91,020.
- That’s $21,684 more than median income ($69,336) for a four-person household in Kentucky in 2015.
Program Would Lead to Less Revenue for Investments in Students
The credit would also have a large, negative fiscal impact on the Budget of the Commonwealth, taking money away from our schools and other budget priorities – why Ed Choice tax credits are also called “back door vouchers” and “neo-vouchers.” The estimated state revenue loss in the sixth year of the program – the size of all credits awarded that year – is $76.3 million. The high rate of the credit is part of the reason for the cost, in addition to the fact people or businesses can carry it forward for up to 5 years to reduce tax liability.
To put $76.3 million into context, it’s about as much General Fund money ($77.7 million) as is budgeted for Family Resource and Youth Service Centers (FRYSCs) and Extended School Services (for students who need additional instruction) combined in FY 2017.
And though the credit would be successful in putting more money into private schools – by shifting those resources away from public investments – it may not succeed in stimulating new charitable giving to private education. The high rate of the credit – 90 cents back for every dollar donated – means donors can give much smaller actual gifts, with the state more than making up the difference.
- Without the credit: At an actual cost to the donor of $940 once the 6 percent charitable deduction is factored in, a donor gives $1,000. The $60 difference is a state tax expenditure.
- With the credit: The same donor pays only $300 for a $3,000 donation once the 90 percent credit is factored in. The $2,700 difference is a state tax expenditure.
Ed Choice Would Allow Some Wealthy Kentuckians to Turn a Profit
The credit is so generous it would actually allow some wealthy taxpayers to make money off their donations by “stacking” state and federal tax breaks. A report from the Institute on Taxation and Economic Policy explains how this would work, indicating that under Kentucky’s proposed tax credit, “donors” could make large profits.
- A “donor” gives $100,000 which, once the $90,000 state credit is factored in, costs her $10,000. At the federal level – where she owes taxes under the federal Alternative Minimum Tax (AMT) at a rate of 28 percent – she deducts the full $100,000 gift, reducing her federal tax liability by $28,000. On net, she receives a total of $118,000 in tax benefits ($90,000 plus $28,000) for an original donation of just $100,000.
- In the most extreme case of a donor taking the largest state credit available ($1 million) as well as the federal charitable deduction at the top AMT rate (35 percent), she could receive a profit of $277,778.
This generosity is why Ed Choice credits in other states are exhausted as soon as they become available each year. Lawyers and accountants recognize the profit potential, even advertising to clients:
- “This is a huge opportunity for those of you in the AMT, as a donation to an SGO…will actually go further to put money in your pocket.” – Alabama CPA’s newsletter.
- “When you donate, you will receive both a Georgia state tax credit AND a federal charitable deduction. You will end with more money than when you started.” – Georgia’s Pay It Forward scholarship website.
Data from the IRS shows that in 2014, 31,710 Kentuckians owed taxes under the federal AMT. 85 percent had incomes over $200,000 per year.
The Ed Choice tax credit is poorly designed, provides subsidies to the wealthiest Kentuckians and shifts much-needed resources away from public schools and other investments.