American Prospect: How States Turn K-12 Scholarships Into Money-Laundering Schemes

This article was originally published in The American Prospect.

By Carl Davis

Politicians have long had a knack for framing policy proposals, however controversial, in terms that make them more palatable to voters.

This is why unpopular tax cuts for the wealthy are often sold as plans to “invest” in America or to stimulate “growth.” Likewise, school voucher programs that funnel public money to religious schools are cast as “school choice,” because underwriting parochial schools with taxpayer dollars is controversial.

The “choice” frame has heightened public awareness of school voucher programs, and helped their advocates make significant inroads in convincing states to allow the use of public dollars for private schools. Obscured in the spin, however, is how some states, in their zeal to subsidize private schools, have created an egregious tax scam that allows wealthy taxpayers to profit by donating to private school scholarship funds in return for lucrative tax credits.

Many states have constitutional provisions that expressly prohibit the use of public dollars for private religious schools. To sidestep these prohibitions and public aversion to the practice, voucher proponents and their legislative allies in 17 states have created generous tax credits to encourage taxpayers to donate to private school scholarship funds.

“Neovouchers,” as these scholarship funds are often called, have received considerable attention as education policy initiatives, but their full impact as tax policies has drawn less notice. Critics who object that vouchers drain resources away from public schools would be doubly outraged if they knew how these vouchers were, in some cases, fleecing the public till. By offering tax subsidies in exchange for donations to private school scholarship programs, states are using private citizens as middlemen. Rather than include line-items in state budgets for spending on school vouchers, lawmakers ask taxpayers to undertake such spending on the state’s behalf, in return for a generous tax giveaway.

But with profit-making “neovoucher” schemes, states supercharge the incentive to donate, rewarding charitable gifts to private schools much more handsomely. Louisiana, Oklahoma, Pennsylvania, Rhode Island, and Virginia, for example, all provide tax credits worth between $65 and $95 on every $100 donated. Alabama, Arizona, Georgia, Montana, and South Carolina go even further by providing dollar-for-dollar tax credits: Donate $100, and receive $100 back in tax credits.

Because taxpayers are also permitted to claim a federal charitable tax deduction on their donations to “neovoucher” programs—even if they were already fully reimbursed for those gifts by their state governments—the result for some taxpayers is a tax cut as large as $1.35 for each dollar donated.

Like many tax loopholes, this one is not geared toward ordinary taxpayers. A quirk in federal law limits the benefit primarily to high-income taxpayers. So, in effect, a handful of states have created elaborate tax schemes that allow wealthy taxpayers to generate risk-free private returns of up to 35 percent. A one-year, guaranteed return of 35 percent on a legitimate investment is uncommon, and a publicly funded return of that size on a so-called charitable donation is patently outrageous. This perverse use of the tax code on two fronts should raise the ire of taxpayers everywhere.

The money-making aspect of these “neovouchers” is not lost on organizations running scholarship funds or on wealth managers.

One organization based in Georgia, for example, brags to potential donors that, “you will end with more money than when you started.” Similarly, a tax lawyer in Alabama notes on her firm’s website that for some taxpayers, “donating” will “put money in your pocket.” And private schools in Oklahoma and Pennsylvania have demonstrated the potential monetary gains of “donating” with hypothetical examples that show the financial returns for participants in their states’ programs.

Perhaps the most candid marketing language, however, comes from a wealth-management firm in Virginia. It notes that a taxpayer can enjoy a savings that is “more than their original donation,” before going on to explain that “there is very little logic to the tax code. Even if you don’t agree with the law, you should take advantage of the tax benefits.”

Until these tax credits are repealed or reformed, it will remain hard to argue with that conclusion. But it doesn’t make it any less shameful.