In the first day back for the 2019 Kentucky General Assembly after a break, members filed House and Senate bills creating a private school tax credit program in Kentucky. At a time when Kentucky’s public schools are dealing with a decade of cuts – deeper than in almost all other states – these programs would transfer a large and growing amount of public resources to private schools.
Rich tax break will be very costly for state and harm public schools
Direct public spending on private schools through vouchers is prohibited by Kentucky’s constitution. Accomplishing the same purpose through the tax code instead with an almost 100 percent tax credit seemingly circumvents this prohibition, which is why these programs, currently existing in 17 other states, are also called “back door vouchers” or “neo-vouchers.”
For donors of cash and marketable securities to private school scholarship granting organizations (SGOs), the proposed program would carve out a large tax break against individual, limited liability, corporate and bank franchise taxes. At 95 cents for every dollar of donations up to $1 million – increasing to 97 cents for multi-year donations – this incredibly rich tax break is 19 times bigger than the state’s charitable deduction for other kinds of giving, and would be the most generous tax credit offered in Kentucky. And it allows donors with less tax liability than tax credit to carry forward the unused portion for up to 5 years.
The cost of the tax break is capped at $25 million in the first year, and if 90 percent of that amount is utilized, the cap will grow by 25 percent the following year. It is very likely the full cap will be used because “donors” can ensure an almost complete return of the amount contributed due to the generosity of the credit. In addition, some donors may be able to even turn a profit from giving (described below). This large payback allows the individuals, businesses and financial institutions making the contributions to directly transfer public resources to private education at nearly no cost to themselves, or even to their personal financial gain.
This is why the Legislative Research Commission estimated last year in a fiscal note on a nearly identical proposal that the program would cost $50 million by its 4th year. If the legislature were to extend the program beyond its five-year sunset, the cost could easily grow to $186 million by its 10th year (Florida’s program has the same growth provision, and costs have escalated in recent years from $229 million in 2013 to $874 million this fiscal year).
To put these large fiscal impacts into context – not just in terms of their size relative to other priorities but also in terms of how this diversion of public resources will hurt Kentucky’s already deeply underfunded public schools – in fiscal year 2018, the state budgeted $29 million for textbooks and teacher professional development combined, and in 2019-2020, these appropriations were cut from the budget altogether.
Public resources will subsidize tuition for relatively well-off families
Though proponents suggest these tax breaks are a way to provide a private school option to families who would otherwise not be able to afford it, the proposal insufficiently targets 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 $25,750 by 185 percent, and then by 200 percent yields $95,275.
- That’s $21,930 or 30 percent more than median income ($73,345) for a four-person household in Kentucky in 2017.
Under these criteria, according to Census data, 72 percent of Kentucky kids would be eligible to receive a scholarship. A natural consequence is that many scholarships will go to families who would have figured out a way to pay for private school tuition even without a scholarship, and public resources will subsidize private education without necessarily increasing access for low-income families. Programs in other states that do not target low-income public school students end up instead serving families with kids already enrolled in private schools.
The bill’s proponents suggest it ensures a certain share of scholarships go to students in need, but in effect, the bill does not prevent a large share of scholarships from going to economically mobile, upper middle-class families. Scholarships are awarded first to students who received one the previous year and their siblings. Then and only then, if any money is left over, a share is allocated to students in need. Specifically, if any scholarships remain after priority is given to past participants and household members of participants, then from that amount, 90 percent of the statewide share of public school students who qualified for free and reduced (which amounts to 66 percent in 2019) must be allocated to first-time students with special needs, living in foster care, or whose income does not exceed the reduced price meal eligibility ($47,638 for a family of 4). That still leaves 1/3 of the remainder of scholarships for students who can meet the higher income threshold.
Savings to schools are not real
Neovoucher advocates claim that rather than losing revenue as a result of this program, public schools will come out ahead financially – pointing almost exclusively to analyses done by Martin Lueken of Ed Choice, a national group in favor of private school tax breaks. In fact, Kentucky advocates of the bill have been sharing with legislators a “fiscal impact statement” written by Lueken and crafted to look much like the LRC’s fiscal notes.
Lueken’s analysis is based on the idea that scholarships to private schools cost less per pupil than a public education, and looks at existing programs in other states to back up these claims. However, a closer examination by the National Education Policy Center at the University of Colorado reveals these hypothetical savings are unsubstantiated:
- When a student switches from a public to a private school and the public school loses its state allotment for that student, the public school may be able to reduce spending on certain variable costs related to the individual student (obviously, fixed costs on things like facilities, maintenance and debt service don’t go down). Lueken asserts these variable costs are reduced by more than state funding goes down, but his analysis is not transparent. He does not explain which variable costs are associated with individual student enrollment, or how individual student characteristics impact costs.
- Any savings would have to come from students leaving public schools to attend private schools. They would have to “switch.” But a big problem with the proposal in Kentucky is that the program will likely end up serving some families who would never have attended public schools to begin with. And based on independent analyses, the “switcher” rate Lueken uses to support his claims is too high.
- Even if we assume that a high number of students switch from public to private school in a district with multiple schools, students switching will be disbursed across different schools and grades, making it much less likely that a district will be able to substantially reduce overall costs, since the impact in any one school and any one class will likely not be large enough to allow for reductions in staffing and other expenses.
What this all means is that schools are likely to lose more state funding than their costs are reduced when students do actually switch from public to private schools, even while a large amount of tax revenue for public school funding will no longer be available.
Program still allows “donors” to profit
As mentioned previously, the proposal would provide a credit of 95 or 97 cents for every dollar donated. To qualify for the tax credit, taxpayers “shall elect to claim a federal and Kentucky contribution deduction” that does not exceed the portion of the contribution that has not been refunded by the credit. In other words, assuming this provision is properly enforced (there are no provisions requiring that donors report how they claimed the donation for federal tax purposes), a donor could still recoup more than 97 percent but less than 100 percent of their donation.
There is a new proposed federal regulation that, if it becomes final, could provide a partial backstop to the lucrative tax shelter created by these programs under which donors could actually profit. It’s worth noting that private school tax credit proponents have spoken out against this proposed rule, and time will tell whether they have been successful in protecting their interests in the final regulation.
Nothing in the legislative proposals, nor in the proposed federal rule, however, would address the fact that donors of stocks could turn a profit from their “donations” to SGOs. Typically, when a stockholder sells an asset that has appreciated in value over time, he or she owes capital gains taxes on the increase in value. However, when that stock is donated to an SGO, no capital gains taxes are owed. This tax shelter, on top of donors’ ability to recoup nearly 100 percent of the fair market value of the stock through the state tax credit, is a windfall for wealthy investors.
Especially at a time when Kentucky can’t afford to pay for school buses, school facilities improvements, textbooks and other instructional materials, the legislature should reject proposals to hand over tens of millions of dollars, growing to hundreds of millions over time, to private schools.
