Tuition Tax Credits: A Model for School Choice

Brief Analyses | Education

No. 384
Wednesday, December 12, 2001
by Lisa Graham Keegan

Parents seeking educational opportunities for their children are now finding more options available to them. Inspired largely by the success of Arizona's Tuition Tax Credit Program, a number of states are establishing tax credits to support scholarships that families may use to send their children to both public and private schools.

While it was not the first state to implement such a program, the Arizona model merits close scrutiny as a primer for success, particularly because it has withstood legal challenge and was deemed constitutional by the Arizona Supreme Court in 1999. Similar programs have been enacted over the past year in Pennsylvania and Florida and are being considered in a number of other states, including Ohio, which held its first hearings on the issue in the autumn of 2001.

Arizona's Tuition Tax Credit Program.

The Arizona program is relatively simple. Taxpayers who make a voluntary donation to a school tuition organization (STO) of their choice receive a matching (dollar-for-dollar) tax credit up to a maximum of $500. Thus when taxpayers make a $500 contribution, they reduce their state tax payments by $500.

STOs are nonprofit organizations, required by law to allocate at least 90 percent of their revenue to scholarships or grants for students to attend private schools. More than 30 STOs have been established since passage of the law. STOs are permitted to choose the schools for which they provide scholarships, are not required to make tuition available for every private school in the state and are free to decide which students receive scholarships and in what amounts. Parents, in turn, choose the STO to which they will apply to for assistance, based on the schools the STO serves. Because the STOs set their own parameters, the size of scholarships varies. They range from about $600 to $3,389; the average for the 2000-2001 school year was $856.

Opponents of the Arizona program immediately challenged it as unconstitutional, arguing that it allocated public funds to private and religious schools. What eventually helped the program withstand the legal challenge were two characteristics of the enabling law.

First, under the scholarship program, choice is applied at two levels, neither of which involves the state:

  • The taxpayer cho-oses whether to donate and which STO to donate to, and
  • The parent chooses to apply directly to the STO for a scholarship.

Thus the state neither directly allocates public money to private institutions nor endorses religious versus nonreligious schools.

Second, the program offers taxpayers a matching (dollar-for-dollar) tax credit up to $200 for donations to public schools. The inclusion of tax incentives to directly assist public schools helped sell the program not only to the legislature but also to the public.

Success of the Arizona Program.

Arizona's experiment with using tax credits to support school choice has been enormously successful:

  • Since the 1999 ruling by the Arizona State Supreme Court, the total number of taxpayers making donations to STOs has leapt from 4,247 in 1998 to 37,368 in 2000. [ See the figure ]
  • In 1998, $2 million in funds was donated to provide $167,650 in scholarships for 326 families.
  • By 2000, the state collected $17.2 million in donations to fund $12 million in scholarships for nearly 15,000 students.

A report by the Cato Institute estimates that by 2015, the scholarship credit will generate more than $58 million per year to fund scholarships for nearly 37,000 Arizona families.

The majority of STOs report that financial need is the primary criterion used to determine eligibility for scholarships. Between 70 and 80 percent of scholarships are being distributed to low-income families, offering these families choices that include private education - choices not traditionally available to poor and disadvantaged families.

The Pennsylvania EITC.

Pennsylvania recently established Educational Improvement Tax Credits (EITCs), which employ the state tax code to allow private educational choice. While structurally similar to Arizona's program, the Pennsylvania program differs in four ways:

  • First, the EITC authorizes tax credits to businesses rather than individual taxpayers.
  • Second, credits are authorized for contributions not only toward scholarships for private schools, but also toward innovative education programs in public schools.
  • Third, unlike the dollar-for-dollar match in Arizona, Pennsylvania's tax credit is 75 cents on the dollar; for every dollar contributed a business can reduce its taxes by 75 cents.
  • Finally, unlike the meager limit in Arizona, Pennsylvania's companies can claim as much as $100,000 in tax credits.

Under the Pennsylvania system, a business can contribute $133,333 to either a scholarship organization or an educational improvement organization to receive the $100,000 maximum tax credit. These contributions can be in cash, personal property or services. Total tax credits authorized for both the scholarship and educational improvement programs credits are limited annually to $30 million - $20 million for the scholarship program and $10 million for educational improvement. Credits are awarded to participating businesses on a first come, first served basis until the cap is hit.

The scholarship organizations - similar to Arizona's STOs - determine the parameters of the scholarships they will award and, as in Arizona, parents may choose certain organizations over others based on the schools for which they provide scholarships.

Similarly, the educational improvement organizations administer the portion of EITC contributions targeted toward educational improvements, which help provide schools with advanced academic programs, enhanced curricula or other approaches to educational excellence described in state guidelines. Both the scholarship organizations and the educational improvement organizations are nonprofit and tax exempt, and must spend 80 percent of their receipts on the services they provide.

A Model Approach for Other States.

As the Arizona and Pennsylvania models have shown, it is possible within the confines of the tax system to provide parents with genuine school choice.

A key to the success of these programs lies in their relative simplicity. Neither imposes any hidden costs. Both are easy to understand, easy to sell to the public and simple to administer - so simple, in fact, that Arizona's entire tax credit program takes up only seven brief paragraphs in the statute, and Pennsylvania's more technically complicated program required only seven pages of a 33-page bill.

Voluntary tax incentives are an attractive - and constitutional - way for taxpayers and businesses to support and enhance educational opportunities beyond those provided through basic state taxes. The generosity of these taxpayers allows families looking for quality schools the option of expanding their choices to include not only the public and charter schools across town, but also the private schools in their own community.

Lisa Graham Keegan is CEO of the Education Leaders Council, a nonprofit, nonpartisan organization of active education reformers, and is a former Arizona Superintendent of Public Instruction.

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