AZ Newspaper Lets Rip on Tax Credits

August 6, 2009

(Guest Post by Matthew Ladner)

In the climax of the Branagh film Dead Again the protagonist struggles with the villain over a pair of scissors. The winner is all but certain to use them to knife the loser to death. Losing control of the scissors, the villain (played by Derek Jacobi) says in classic British understatement “I shall be very interested to see what happens next.”

The East Valley Tribune has a three part series titled Rigged Privilege on the Arizona tax credit system.  At the time of this writing, they are only through parts one and two.

A little background. In 1997, the Arizona legislature created the nation’s first scholarship tax-credit law. Donors were allowed to make a $500 donation to a non-profit group, which could then give scholarships for children. State oversight in the bill was limited to some reporting. The law specified that scholarship organizations had to give scholarships to more than one school, and that donors could not make a donation for the benefit of their own child. The law allows 10% of funds to be spent on administration.

The bill had been means-tested, but the sponsor reluctantly dropped the means test during the process. The bill had almost no support from Democrats, and the last vote needed to put the bill over the top agreed to support it only if it did not contain a means test. Over the years, the maximum amount that could be donated for a married couple filing jointly has been raised to parity at $1,000. Arizona lawmakers created a corporate credit in 2006 which included a means test.

Last year the credit raised about $55 million dollars.  For a bit of perspective, that is about 10% of the annual operating budget of Arizona’s largest school district. The credit created 28,234 scholarships last year. With more than ten times the money, the state’s largest school district serves less than three times as many students as the tax credit. 

Sound like a bargain so far? Don’t answer yet! This is not a program with a lottery, and thus it does not lend itself to a high quality test score evaluation with a proper control group. The Goldwater Institute has however surveyed Arizona public and private high school students and found substantially higher levels of student satisfaction, perceptions of academic rigor and school safety, and higher levels of political tolerance among private school students (forthcoming). The credit in short produces a better education at a lower cost according to the students.

A number of organizations employ means test for students. Even those that do not are aiding some as yet uncounted number of low-income families. I have personally met students whose academic careers and lives were changed by the opportunity that this program created.

Having said all of that, the EVT details what happens with a program containing minimal oversight and ultimately having no one, in either the private or public sphere, with the authority to police the program: abuse.

I encourage you to read the article for yourself. One of the stories focused on a scholarship group who somehow raised money for a few years but failed to provide any scholarships (the law requires you to spend 90% of your funds on scholarships). Federal law prohibits designating a beneficiary for a charitable donation, for obvious reasons. Some scholarship groups have engaged in “recommendations” for donations, and have appeared to engineer donation swaps among parents. Grey area material, at best.

Groups maintaining accounts for individual students seems like a bright-line violation of federal tax law. I don’t yet understand the workings of this “tax credit for fetuses” business, but let’s just say for now that it seems like a pretty clear perversion of the intent of the law, even if it is legal, which it may not be.

So I’m inclined to think that the Arizona tax credit system could use a clean up. Opponents of parental choice have predictably seized upon this report as proof that the whole idea of tax credits is some evil corporate plot to destroy Western civilization, etc. Such people could use some Valium sprinkled in their coffee. In the big picture, the tax credit is providing higher quality education opportunities than average at a dramatically lower cost.

Does the program need a referee with the power to throw a flag and assess a penalty, even eject a player from the game? Yes. The absence of such a referee is basically not only inviting, but begging for abuse.  Should lawmakers means test the program? It depends on your perspective, but I’d say no, or rather, only conditionally yes. I would readily agree to a means test if we can do the same for public schools. The average scholarship in this program is in the neighborhood of $2,000. Average public school spending in the state is just south of $10,000. As long as we are handing out $10,000 to the children of North Scottsdale millionaires, I can’t see a reasonable argument to deny them $2,000 instead to save the rest of us some money.

There are better ways to address equity concerns than a means test. When I worked at the Alliance for School Choice, we developed a set of model bills in cooperation with the Friedman Foundation and the American Legislative Exchange Council. In our tax credit bill, we included a requirement that scholarship organizations give a percentage of their funds to free and reduced lunch eligible children equal to the state average. Around half the children in Arizona public schools are free and reduced lunch eligible, and under this provision, STOs would have to give about half of their dollars raised to free and reduced lunch eligible students.

Groups would be free to do more than this (I serve on the board of a group which only gives scholarships to free and reduced lunch children) and such a requirement would obviously need to be phased in order to avoid serious disruption. Half the kids in Arizona public schools are free and reduced lunch eligible, but I wouldn’t count on them getting half the total K-12 money. Adoption of such a provision would likely make the tax credit more focused on equity than the public school system.

Carrie Lips Lukas, writing for the Goldwater Institute in 2003. called for a series of reforms. Last year, I fundamentally revamp the system by creating a personal use credit and means testing the scholarship credits at the free and reduced lunch level. This would expand parental choice, eliminate swapping, and create a universal system of choice with an advantage for the poor (who could benefit from both credits). Scholarship credits would still be vital, but would be purely charitable in nature.

When presented with this type of information, the first instinct of some will be to deny it, to hunker down, to accuse our enemies of far greater misdeeds, or to otherwise try to put lipstick on a pig. Good luck with that.  It is blindingly obvious to me that Arizona’s tax credit is system is a good program overall that suffers from specific weaknesses that can and must be addressed.  Otherwise, writing articles like this one will become the journalistic equivalent of using a shot gun to shoot fish in a bucket.