Bills have already been filed in both the Senate and the House this session that would further threaten resources for Kentucky’s already underfunded public schools and other services, allow high-income Kentuckians to make money from “donations” to private schools and allow relatively well-off Kentuckians to benefit from the private school scholarships the bills would create. These proposals, referred to by proponents as “Ed Choice” tax credits, are thinly disguised private school vouchers that shift resources from public services to private schools.
Tax Breaks Will Reduce Resources for Kentucky’s Public Schools
The program gives large credits against individual, corporate, bank franchise and pass-through taxes to donors of scholarship granting organizations. Individual, corporate and financial institution donors in the Senate proposal would get a 90 percent credit for every dollar they donate up to $1 million. The House proposal, also capped per donor at $1 million, has an even higher credit of 95 percent (with the potential to increase that amount up to 97 percent for multi-year contributions). Both versions generously allow 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 in both bills at $25 million in the first year. Because donors can stack the tax benefits of the credit at the state and federal level to make them costless or even allow them to turn a profit (described below), full utilization of the program is very likely. Due to provisions that allow the program to grow if a large share of the available credits are awarded each year, the Legislative Research Commission (LRC) estimated last year (in a fiscal note on a similar bill) that maximum expansion would occur and such a program in its sixth year would cost the state $76.3 million. If the legislature were to extend the program beyond the 2023 sunset date, the cost could easily grow to an enormous $233 million by its 10th year.
The aforementioned growth provision is identical to the one in Florida’s program, which has seen its costs grow from $229 million in 2013 to $699 million this fiscal year. These large, negative fiscal impacts are a diversion of resources away from our schools and other budget priorities to private schools. This is why such tax breaks are also called “back door vouchers” and “neo-vouchers.” To put the magnitude of the potential fiscal impact into context:
- $25 million was the total amount originally budgeted for the current school year for Extended School Services (programs for students who need additional instruction).
- The state budgeted about $266 million from the General Fund in 2018 for its entire range of Next Generation Learner school support programs like Family Resources and Youth Service Centers, preschool, textbooks, gifted and talented programs, afterschool programs and dropout prevention.
Advocates of the tax breaks argue that rather than losing revenue, the state and local school districts will come out ahead financially. This argument is based on the claim that scholarships to private schools cost less per pupil than a public education. However, closer examination reveals these hypothetical savings are unsubstantiated:
- When students switch from public to private schools, public districts cannot proportionally reduce fixed costs on things like facilities, maintenance, debt service and transportation. Advocates’ analyses that find public savings assume variable (rather than fixed) costs make up a large portion of total costs yet do not provide sufficient data or analyses supporting these assumptions.
- A large share of scholarships go to families whose kids already attend private schools, or who would go to private schools anyway. Kentucky’s proposed program does not target students who are currently enrolled in public schools, so the scholarships will drain money from public schools without reducing schools’ variable costs proportionately.
Program Will Allow Wealthy Kentuckians to Turn a Profit
As mentioned, the bills would allow a state return of 90 cents for every dollar donated in the Senate version and 95 cents for every dollar given in the House version. But that’s only part of the subsidy, because some wealthy donors are also eligible for federal tax breaks that mean they can actually make money off their donations.
For example, due to recent federal tax law changes, some wealthy taxpayers would be able to make money through a loophole created by the Senate proposal. These wealthy filers – with a substantial state and local tax liability – previously would have seen a federal tax cut associated with higher charitable deductions fully offset by a reduction in their state and local tax deduction (SALT). However, under the new $10,000 SALT cap, filers who will still hit that limit regardless of the private school tax credit will see their state taxes go down under the credit without the offsetting reduction in their SALT deduction.
- A donor who gives $100,000 is taxed at the top marginal federal tax rate of 37 percent, itemizes her deductions, and still has over $10,000 in state and local tax deductions even after the tax credit reduces her state tax liability.
- She receives a $90,000 state tax credit, recouping 90 percent of her donation.
- On her federal income taxes, she claims her full $100,000 charitable deduction, reducing her federal tax liability by $37,000 (37 percent). On net, she has gained $27,000.
Language in the House bill tries to prevent profitable state and federal benefit stacking by asserting that 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. Assuming that would be properly enforced, this means the donor would still recoup 100 percent of his or her donation.
But nothing in either the Senate or House proposals prevent donors from utilizing a second way to stack state and federal benefits by “donating” securities instead of or in addition to cash gifts. 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 a Scholarship Granting Organization, no capital gains taxes are owed. This tax shelter, on top of donors’ ability to recoup 100 percent of the fair market value of the stock or more, is a windfall for wealthy investors.
This profit potential is well-understood and even advertised by program advocates. For example, Georgia’s Pay It Forward scholarship website states “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.”
Proposals Are Not Targeted to Low- to Moderate-Income 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, neither proposal filed this year 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 $24,600 by 185 percent, and then by 200 percent yields $91,020.
- That’s $20,049 more than median income ($70,971) for a four-person household in Kentucky in 2016.
The eligibility criteria and priorities established for granting scholarships will exacerbate this situation over time, as first priority is given to students who received a scholarship in the past, and household members of a student who has received a scholarship in the past, regardless of whether family income has grown beyond the requirements to initially qualify for a scholarship. In other words, each child in a large family whose income rises over time above the threshold remains fully eligible for a scholarship, and those families are given first priority when limited scholarship funds must be spread across all eligible children. Programs in other states that do not target low-income students end up instead serving families with kids already enrolled in private schools.
Especially at a time when Kentucky can’t afford to pay for school buses and school facilities improvements or keep up investments in Family Resource and Youth Centers, textbooks and other instructional materials, the legislature should reject proposals to hand over a growing pot of money to private schools and for tax subsidies to wealthy individuals.