Five Flaws in Arizona's Private School Tax
by Lawrence C. Mohrweis, Ph.D.
Arizona 's school tax credit law allows taxpayers to receive tax credits for fees and donations made to support public school extracurricular activities and for donations made to school tuition organizations for private schools. Ask any member of the Arizona Society of CPAs and they will most certainly tell you that State Tax Form 322 (Credit for Fees Paid to Public Schools) and Form 323 (Credit for Contributions to School Tuition Organizations) are two of the most popular tax credit forms that they prepare for their clients.
Arizona 's school tax credit program has been praised by policymakers at the national level as one of the most innovative school choice programs in the nation. Several states view Arizona 's statute as a model to develop their own school choice programs.
However, beneath all the admiration and praise are some serious flaws. As noted in the AZ CPA (July/August 2002), I had some deep reservations with how the private school tax credit program was being operated. 1 We now have empirical data to assess whether those concerns were justified. In addition, the legislature is considering a major expansion of the private school tax credit (House Bills 2378 & 2425) to include a corporate tax credit. It is a good time to re-examine school tax credits. There are five problems with the private school tax credit program:
Flaw Number One: No income test for financial need. Nationwide, taxpayer-sponsored scholarship programs have been designed with family income caps to ensure that grants go to low-income students. Taxpayer-sponsored scholarships, like the voucher programs in Cleveland and Milwaukee and the corporate tax credit programs in Florida and Pennsylvania , require that recipients be from families with financial need. Arizona is the only state that has a taxpayer-sponsored scholarship program that is devoid of any income-level test. Scholarships in Arizona can be awarded to children from families making six-figure incomes. In 2003, the National Center for Education Statistics estimated that 4,400 students were eligible for the free or reduced-price lunch program in Arizona 's private schools, 2 yet 19,373 scholarship grants were awarded. 3 In other words, no more than 23 percent of Arizona 's taxpayer-sponsored scholarships were awarded to low income families.
Flaw Number Two: Specific child programs. Some school tuition organizations allow donors to name a child for a scholarship at the time they make a donation. For example, a grandmother can ask that her donation go specifically to her grandson as a scholarship. Many school administrators promote specific child programs noting that families, regardless of income, can receive a free or a reduced-cost private school education paid for by the State of Arizona by getting as many family members and friends to make tax-credit donations in their child's name. Data from Arizona 's Department of Revenue shows that thousands of scholarship grants in Arizona are flowing to private schools located in wealthy suburban areas. In contrast, with Ohio , Wisconsin , Florida and Pennsylvania 's programs, most taxpayer-sponsored scholarships flow to intercity private schools serving low-income children.
Flaw Number Three: No regulatory enforcement. By law, school tuition organizations are required to submit annual reports to the Department of Revenue by February 28. However, The Department of Revenue does not certify school tuition organizations. There is no penalty in the statute for failure to report.
Flaw Number Four: Potential abuse of the 10 percent rule. School tuition organizations must allocate at least 90 percent of their revenue to scholarships but have full and complete discretionary power over the remaining 10 percent. In one case a school tuition organization spent $52,836 on a church project. 4 This raises an interesting question. Is it good public policy to have tax-credit donations being used for church project fundraising?
Flaw Number Five: No independent audits. Even though school tuition organizations handle millions of dollars they are not required to have audits by independent certified public accountants.
The flaws listed above relate only to the private school tax credit. The media has already extensively documented the problems with the public school tax credit for extracurricular activities (tax form 322). Specifically, schools located in wealthy districts receive a disproportionate amount of tax credit donations compared to schools located in poor areas.
Recommendations
Yes, school tax credits are popular with clients. However, given the serious deficiencies as noted above maybe the time has come to consider eliminating both public school and private school tax credits. For example, it would make more sense to take the millions of dollars related to the public school tax credits and allocate the total on a per-student basis directly to public schools, thereby ensuring that all schools in the State are treated fairly. With respect to private schools, maybe Arizona policymakers should mo del its program after the Cleveland voucher system, upheld as constitutional by the U.S. Supreme Court, as a way to provide taxpayer-sponsored scholarships to students.
Finally, with respect to current legislation, the bills on the corporate tax credit proposal do address flaws number one (no income test for financial need) 5 and number two (specific child programs) 6 . They are silent on flaws number three (no regulatory enforcement) and number four (potential abuse of the 10 percent rule). For flaw number five, the bills require that only a review be performed rather than an audit. With the corporate tax credit projected to bring up to $55 million by the year 2014, nonprofit organizations collecting such large sums of money should be audited by a CPA.
A recent policy report by the Goldwater Institute (Januar y 2005) provides an in-depth analysis of private schools. 7 The study notes that private schools are extremely valuable and are essential to Arizona's educational marketplace. I firmly believe that we need to support private schools, however, I think now is the time for policymakers to take a really hard look at school tax credits. Can a better way be found to support the educational needs of students attending our public and private schools?
Lawrence C. Mohrweis, PhD. is a professor of accounting at Northern Arizona University . He volunteers as president of a school tuition organization and can be reached at lawrence.mohrweis@ nau.edu.
Endnotes
1. Lawrence C. Mohrweis, “Private School Tax Credits: What CPAs Should Know,” AZ CPA , July/August 2002.
2. Carrie Lukas, “The Arizona Scholarship Tax Credit: Providing Choice for Arizona Taxpayers and Students,” Goldwater Institute Policy Report, No. 186, December 11, 2003 , 18.
3. Carrie Lukas, “The Arizona Scholarship Tax Credit: Providing Choice for Arizona Taxpayers and Students,” 10.
4. See “Statement 1, Form 990, Part II, Line 43, Other Expenses” for the year 2002 of the Arizona Christian School Tuition Organization. This information is publicly available on www.guidestar.org with the entity listed as the “East Valley Christian School Tuition Organization.”
5. The bills (HB2378 & HB2425) state: “Family income does not exceed 185 per cent of the income limit required to qualify a child for free or reduced price lunches under the national school lunch and child nutrition acts.”
6. The bills (HB2378 & HB2425) state: “The tax credit is not allowed if the taxpayer designates the taxpayer's contribution to the school tuition organization for the direct benefit of any specific student.”
7. Vicki Murray and Ross Groen, “Survey of Arizona Private Schools: Tuition, Testing, and Curricula,” Goldwater Institute Policy Report No. 199, January 5, 2005 .
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