Policy brief – LB 295’s tax credits raise a multitude of concerns
(EDITOR’S NOTE: This is an updated version of a policy brief we originally published on Feb. 21. We are resending this brief as LB 295 has been placed on the Legislature’s agenda for today.)
Under scholarship tax credit programs as created by LB 295, the state would forgo revenue to provide a tax benefit to those who make donations to private school scholarship-granting organizations (SGOs), which in turn provide scholarships to students in private K-12 schools. LB 295 creates much greater tax benefits for donations to SGOs, as compared to all other nonprofits. Furthermore, scholarship tax credits can make it possible for some wealthy donors to profit by way of the tax code.
Scholarship tax credits much more lucrative than other types of donations
Tax credits enhance the tax benefit of donating to scholarship-granting organizations, as opposed to tax deductions for other types of charitable donations. Providing a 100 percent credit for such a donation – as would occur under LB 295 as presently drafted – can result in a dollar-for-dollar reduction in the amount of taxes owed.[1] All other charitable donations reduce taxable income through deductions, which means the tax benefit is worth the amount of deduction multiplied by the tax rate in the tax bracket in which one’s income would have fallen prior to the deduction. A pending amendment to LB 295 (AM2071) would lessen the credit to 75 percent of the donation but still provides more tax benefit than other types of charitable gifts.[2]
A tale of two charitable donations – tax credits and tax deductions
If a married couple filing jointly makes a $10,000 donation to an SGO under LB 295 as presently drafted, they can reduce their state taxes owed by $10,000. Or, if they owe less than $10,000 in state taxes, they can reduce their state tax liability to $0. If the amendment to LB 295 is enacted, their $10,000 gift would reduce their taxes owed by $7,500. On the other hand, if the same couple makes a donation to a non-profit private or public school foundation, they can reduce their taxable income by the amount of their donation. The potential value of their tax benefit will be the amount of their donation ($10,000) multiplied by their tax rate in the bracket in which that income would have fallen. If that income falls in the state’s top income tax bracket of 6.84 percent, the tax savings would be $684.
Scholarship tax credits can allow wealthy donors to profit from tax code
When the impact of the state tax credit proposed in the Legislature is combined with federal tax deductions, some Nebraska taxpayers will be able to actually profit from making such donations. This scenario already occurs in nine states and in some, like South Carolina and Georgia, various scholarship organizations advertise these credits as money-making opportunities.[3] For example, a K-12 private school in Georgia on its website writes that donors can “’profit’ up to 29 percent on the amount donated.”[4]
How LB 295 would let donors turn profits
Profits under LB 295 as presently drafted can occur when taxpayers’ state and local taxes exceed the $10,000 federal deduction for state and local taxes (SALT) and when they are able to claim deductions at the federal level. For example, if the hypothetical married couple above has $20,000 in state tax liability, they can make a $10,000 donation to a scholarship-granting organization and offset their state tax liability by the full amount of the donation. This is a $10,000 value in tax benefits for their $10,000 donation. Then, at the federal level, they can claim their Scholarship Tax Credit gift as a $10,000 charitable donation[5] on their federal tax returns, which if claimed at the top federal tax rate of 37 percent, would provide the couple with a $3,700 tax deduction. That means this couple would experience a combined state and federal tax savings of $13,700 from their $10,000 donation, a profit of $3,700. If the credit is limited to 75 percent as per the pending amendment on LB 295, this couple would experience a combined state and federal tax savings of $11,200 from their $10,000 donation, a net gain of $1,200.
New credit would divert public dollars that can be used to support and improve public education
Creating a scholarship tax credit now would come at a time when our state’s school funding needs are increasing and when state funding of K-12 education has been constrained due to budget shortfalls.[6] This low level of state support leads to a heavy reliance on property taxes to fund schools. Diverting more state resources for scholarship tax credits will make it harder to address state public education needs and increasingly shift the cost of funding K-12 onto property taxpayers.
Tax credit scholarships are not targeted to low-income students
Because the eligibility is not targeted to the lowest-income students, the scholarship tax credits could potentially subsidize the private education of students who would have attended private schools anyway. Under LB 295, students at 370 percent of the federal poverty level (FPL) would be eligible to qualify for scholarships offered under the programs. This means that in 2018, a family of four could make up to $92,870 – putting them in the top 40 percent of Nebraska earners — and still qualify for the scholarships. For context, 370 percent of the FPL is double the eligibility level for free and reduced meals, which is the standard that our public school system considers low-income. This eligibility expansion beyond the traditional definition of low-income students is consistent with tax credit programs in some other states. For example, a study of a scholarship tax credit in Arizona found about 76 percent of the scholarships went to students who already had the means to attend private school.[7]
Scholarship tax credits not likely to create savings for the state
It’s highly unlikely the credit would sway enough children to switch to private schools to create savings in the public schools. In order to generate savings for the state in reduced public school costs, not only would a significant number of students need to switch from public to private school, but those students who switch would need to be highly concentrated in certain school buildings. A large percentage of public school costs are fixed and not able to be reduced without a large reduction in enrollment. For example, if one or two students in a public school classroom leave and go to private school, the public school must still pay the teacher and maintain the facilities in the same way it would have before the students changed schools.
Conclusion
Scholarship tax credits like the one proposed in LB 295 stand to divert state revenue at a time when we are experiencing revenue struggles. Enacting this measure could force lawmakers to make cuts to vital services such as public K-12 education or shift more of the load of funding our schools on to property taxpayers. In light of these factors, we have serious concerns about creating a new tax credit that would reduce state revenue and allow wealthy Nebraskans to turn profits by way of the tax code.
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