Education Funding: Tax Credits Cost the Federal Government Money
McCourt School of Public Policy, Georgetown University
The Issue:President Trump pledged to devote $20 billion in federal funds to expand "school choice" programs for low-income students during the presidential campaign. The administration's budget proposal included $1.4 billion in spending towards school choice initiatives that would eventually "ramp up" to $20 billion. In the absence of greater policy details, many observers have looked at scholarship tax credit programs, especially Florida’s Tax Credit Scholarship Program, as one potential model for how the federal government could fund greater access to private education. A major source of this approach’s political appeal is that it does not require Congressional appropriations but could be passed as part of a tax reform bill instead.
Tax credits may not increase the budget but that doesn’t mean they are free: a $20 billion tax credit would mean the federal government collects $20 billion less in revenue.
- Observers are looking to the Florida Tax Credit Scholarship Program as a potential model for federal policy because President Trump singled it out during his address to the joint session of Congress. Trump also conducted his first school visit as president to a private religious school in Orlando, Florida, that serves almost 300 scholarship recipients.
- Tax credit scholarships allow taxpayers to make a contribution to a scholarship program of their choice and subtract the value —in most cases the full amount of the contribution— from taxes due. As of January 2017, 17 states had such programs. Under a program with a 100 percent tax credit, a $1000 contribution would reduce federal taxes owed by $1000 — essentially making the donation “free” to the taxpayer. Tax deductions, in contrast, reduce taxable income. For example, under the current federal tax code, at the maximum income tax bracket of 39.6 percent, a similar $1000 charitable contribution would reduce taxable income by $1000 and reduce federal taxes owed by $396. In some states, you can get 100 percent state credit, making it a free donation, and then take the federal deduction for your donation. For someone in the 39.6 percent tax bracket, they would save $1.40 in total taxes for every dollar donated to the state tax scholarship program.
- Tax credits and deductions are known as “tax expenditures” because they cost the government money by reducing revenue collected. A $20 billion tax credit would require $20 billion in some combination of federal spending cuts and deficit increases. State scholarship tax credits cap the total amount of contributions to foundations for which the credit can be claimed. This limits the potential revenue loss to the state. Any federal law would need to specify the maximum donation eligible for the credit. It would be important for any federal policy to describe how credits would be allocated if eligible contributions exceed the annual cap.
- The Florida program allows individuals or corporations who donate to non-profit scholarship funding organizations (SFOs) to reduce the amount of their state tax obligation by the full amount of the donation. This is because Florida offers a “100 percent credit,” up to a maximum cap (75 percent of taxable revenue for corporations). The SFO donors receive the tax credit; the low-income families receive the scholarships, which they can use at participating private schools, including religious schools.
- Scholarship tax credit programs specify which students are eligible and whether tuition can exceed the scholarship amount. In 2016-17, Florida families up to 260 percent of the federal poverty level were eligible for scholarships of $5,886. Families are permitted to — and typically must—“top off” these scholarships to pay higher tuition amounts.
- Aside from making the public cost less visible, having a nonprofit intermediary organization like Florida’s scholarship funding organizations administer the program has important policy implications. It allows the funds to be directed to religious private schools, avoiding legal issues were the funds public. Because these funds would be private foundation funds (raised in exchange for federal tax revenue) rather than explicitly federal funds administered through the Department of Education, private schools receiving these vouchers would not necessarily be subject to a variety of state and federal requirements, including serving students with disabilities through special education and participating in accountability systems. States with tax credit scholarships now vary in these requirements for private schools receiving scholarship funds.
- The beneficiaries of a tax credit scholarship would not be limited to families who take up the scholarships funded by them. Donors who receive these credits essentially get to direct their tax payments to the (private) spending program of their choice—the scholarship program—while all other taxpayers must support the full set of federal spending obligations with their payments. Put differently, any taxpayers who would have contributed to such a scholarship fund even without such a tax credit would be able to do so for free with the credit.
What this Means:
Supporting school choice with a $20 billion federal tax credit scholarship program would cost just as much as appropriating $20 billion of federal funds for vouchers. It also would allow a set of donors to choose how a (potentially large) share of its tax dollars are spent, while the rest of the federal tax base remains responsible for funding core federal functions. The details of tax credit scholarship programs—like who is eligible for scholarships, how foundations are formed, and what conditions private schools must meet in exchange for these publicly-subsidized but now officially private funds—matter. Not only do they affect educational choices of scholarship recipients, but they would also impact the size of the deficit and progressivity of the tax code.