As some supporters of school choice are pushing for a federal tax-credit scholarship program, opponents are proposing legislation in Congress that would impair similar programs already operating in 17 states. These programs allow individual and/or corporate donors to claim a full or partial tax credit when they contribute to nonprofit scholarship organizations that aid children from low- and middle-income families.
At the end of last month, Representative Terri Sewell of Alabama announced that she would soon introduce legislation to prohibit taxpayers from claiming a federal tax deduction on contributions to scholarship organizations for which they received a state tax credit. In an interview with Education Week, Sewell’s spokesperson offered five rationales for this proposal. All of them are spurious.
First, he claimed that the proposal would prevent donors from receiving a “double tax benefit” — but most if not all states already allow taxpayers to deduct charitable donations on their state taxes even when they’re receiving a deduction for the same donations on their federal taxes. Moreover, there are hundreds of other tax credits that states offer, including for donations to a wide variety of organizations that aid the poor. To the extent that a “double tax benefit” exists, it applies to nearly all charitable contributions — there is no need to single out scholarship tax credits.
Second, Sewell’s spokesperson argued that the tax-credit scholarship programs “privilege” scholarship organizations “over churches, food banks, and so many other worthy charities.” But that is a matter for state policymakers. Indeed, many of the aforementioned state-level tax credits are for donations to food banks, soup kitchens, homeless shelters, and the like. For example, Arizona offers matching tax credits for every dollar donated to hundreds of organizations that help the working poor with food, shelter, health care, job training, child care, and more. The federal government allows taxpayers to deduct contributions to those organizations from their federally taxable income even if they take the Working Poor tax credit. Again, changing the federal tax treatment for donations to scholarship organizations but not for donations to these other charities makes no sense — unless one has a particular animus against school-choice programs.
Third, Sewell’s office claimed that she is “troubled by the extracurricular programs at public schools [in Alabama] that no longer have financial support while the state’s scholarship system directs money to private schools.” First, it is parents who are directing the scholarship funds to private schools, not the state. The state has zero control over which scholarship organizations taxpayers support or which schools parents choose. Second, it is ludicrous to blame any district school’s financial woes on Alabama’s scholarship program. In the 2016–17 academic year, merely 3,885 out of Alabama’s roughly 750,000 students received tax-credit scholarships worth about $4,200 on average. That amounts to about $16 million in tax credits, which is only around 0.3 percent of Alabama’s more than $4.8 billion in state and local K–12 education spending. Not to mention that the fact that students who switch out of Alabama’s public-school system produce savings for the state.
Sewell’s fourth objection is that the scholarship program is leading to “resegregation.” In fact, however, the high degree of racial isolation is a direct result of assigning children to district schools based on the homes their parents can afford. As the U.S. Government Accountability Office found in a report last year, racial isolation in district schools is a serious and worsening problem. But far from exacerbating segregation, private school-choice programs actually make schools more racially integrated, according to nine of ten studies. (The tenth study found that such programs had no significant effect on integration in schools.) If racial integration is her goal, Sewell should support programs that help low-income minority families enroll their children in the schools of their choice.
The federal tax code should not disadvantage donations to scholarship organizations relative to donations to homeless shelters, soup kitchens, or other nonprofits.
Sewell’s final objection, according to her spokesman, is the most complicated. Relying on a flawed and misleading report by the Institute on Taxation and Economic Policy and the School Superintendents Association, Sewell claims that donors who receive tax credits can “turn a profit” on their donations. What she means is that in some states (the handful that offer dollar-for-dollar tax credits), some donors (those who are subject to the Alternative Minimum Tax [AMT]) can pay less in federal taxes than if they had merely paid their state taxes instead of donating to a scholarship organization.
Here’s how it works. Taxpayers who itemize and are not subject to the AMT can deduct their state tax liability and any charitable donations from their federally taxable income. So if someone owed $1,000 in state taxes, they could deduct that $1,000 from their federal tax liability or they could make a $1,000 donation to a scholarship organization and deduct that from their federal tax liability while taking a $1,000 credit at the state level. Either way they would have given away $1,000 and deducted $1,000 from their federal taxes. It’s a wash.
However, taxpayers subject to the AMT aren’t afforded the same luxury. They can deduct charitable donations but not their state tax liability. Therefore, taxpayers subject to the AMT gain a greater advantage on their federal taxes by making a donation and taking a state tax credit than by paying their state taxes. This difference in tax liability is what Sewell and other opponents of school choice misleadingly call “turning a profit.”
To the extent that this quirk of the tax code is something the feds find troubling, there are numerous ways to address it. Congress could, for example, make state taxes deductible from the AMT. Alternatively, they could forbid taxpayers subject to the AMT from deducting charitable contributions. They could even do away with the AMT altogether. I’ll leave it to the tax experts to determine the best course of action, if any action is actually needed.
In the event that the feds decide to alter how the federal tax code treats donations for which donors received state tax credits, however, they should do so in a manner that is neutral with respect to the type of organization receiving the donation. The federal tax code should not disadvantage donations to scholarship organizations relative to donations to homeless shelters, soup kitchens, or other nonprofits. Sewell has not yet released the text of her proposal, but if it does not apply to all state-level donation credits, then it should be rejected as a naked attempt to undermine school-choice programs rather than a serious effort at tax reform.