Back to School Special: Huge Tax Break for Private Schools Strains State Treasury

A state tax incentive that pays tuition for students in private, mostly religious, schools has failed to meet proponents’ claims that it would cut the state budget and is instead costing Iowa taxpayers millions of dollars, according to a joint investigation by Iowa Public Radio and IowaWatch.

Through the incentive, known as the tuition tax credit program, the state has doled out almost $21 million since it started in 2006, and it is far more generous than any other credit offered by the state, including those meant to create jobs and raise state revenue. For the past four years the program has let many contributors to private school tuition organizations get almost all of their money back from the government.

One donor, who gave $175,000 to scholarship funds, received a credit of $113,750 from the state and was eligible for a $61,250 federal tax reduction, amounting to virtually no out of pocket costs.

Now, some are again questioning whether the tax credit should be reduced and oversight increased.

In pushing the plan, proponents said it would cut the state budget by drawing students from public schools to private schools. But the program has not come close to meeting that promise, according to an analysis of state education statistics, tax credit records and reports and more than a dozen interviews.

“The return on investment has not been meaningful,” said one document from the Department of Revenue.

The document, which is part of a 2009 agency report on all tax credits, noted that proponents of the tuition tax credit program “claimed that it would pay for itself” by cutting public school enrollment.

“That has not come to pass,” Jim McNulty, who manages the program at the Department of Revenue, said in a recent interview.

Instead, it’s been a drain on the state treasury.  Private schools have continued losing students, and the incentives have had no discernible effect on public schools during the program’s lifespan.

“There is reason to take a hard look at this credit,” said Sen. Joe Bolkcom, D- Iowa City.

But the program is not scheduled for a formal review until 2012.

One aspect of the credit that may need review is the lack of information available to the state.

Like the state saw in the now-suspended film tax credit program, which cost taxpayers millions and spurred an ongoing investigation, it has no way to detect abuse.

Moreover, in Arizona, largely because of a lack of oversight, a similar tuition tax credit program fell victim to abuse and misuse and became the target of newspaper and official investigations that prompted major reforms earlier this year.

Although provisions in Iowa’s measure prohibit some of the specific practices that were abused in Arizona, it fails to give the Department of Revenue sufficient tools to keep tabs on the program. Instead, the law relies on the private-school tuition organizations to police themselves.

The IowaWatch and Iowa Public Radio study also found that:

• Almost all of the tuition grants benefit religious schools, putting Iowa civil libertarians on the lookout for a church-state suit against the state;

• The state does not have information to determine whether the tax credits are merely benefiting parents with children already in private schools;
• The law does not require the state to collect sufficient data to allow it to ensure only eligible students – those from low and middle-income families – receive scholarships;
• A 2009 Department of Revenue report noted it has no way to make sure that dependents of program donors don’t receive tuition grants;

Bolkcom said the findings underscore “the dire need we have in the state government to pay closer attention to this part of the state’s spending.”

Since the film tax credit scandal the state has shown increased scrutiny over tax credits. In January, Gov. Chet Culver assembled a panel to review all state tax incentives, including the private school scholarship program. It recommended a reduction to the credit that private school advocates objected to and the legislature ultimately ignored.

‘The most generous tax break of all’

Taxpayers have already helped foot the bill for 25,988 scholarships for private school

students since the state passed legislation in 2006 and are committed to pay for thousands more from $7.4 million in tax credits issued in 2009 for the school year about to start.

The law requires contributors to private schools to funnel their donations through school tuition organizations, sometimes referred to as STOs.

There are 12 such organizations, and they distribute the donations in the form of scholarships to private school students. The organizations issue tax credits to the donors, which they use to claim their contributions when they file their tax returns. A board of directors oversees each organization. The law requires annual independent audits, but the State Department of Revenue does not review them.

The original bill set a $2.5 million cap for the program for 2006 and $5 million for 2007. A 2008 bill raised the cap to its current level of $7.5 million.

In 2009, the school tuition organizations distributed $9.23 million in grants to 9,264 students. The grants were funded by 3,161 private contributions.

“It’s the most generous tax break of all,” said Jim McNulty, the Department of Revenue program manager. He said most of the tax credits that the state gives to business to spur economic activity seldom exceed 10-20 percent. McNulty said the tax credit is so big, it surprises a lot of donors.

“They say, are you serious – It’s 65 percent?” McNulty said in an interview with Iowa Public Radio.

See complete descriptions of the 36 tax credits Iowa offers.

McNulty said such generosity is one reason the state should scrutinize the school tuition tax credit but added that the legislature should review all credits.

Bolkcom would agree.

“I think when people give charitable contributions, it ought to be a charitable purpose,” he said.  “And in the case of this, we’ve taken the charity out of the contribution.”

He would like to reduce the size of the credit, he said.

The tax credit program was meant to serve a dual purpose – to save the state money in the long run and to provide Iowans with a choice between public and private schools. But the private school choices in Iowa are limited almost entirely religious organizations.

All but a handful of the 161 schools in the program are affiliated with a Christian church, and no similar program exists for Iowa’s public schools. For these reasons, the American Civil Liberties Union in Iowa says the program violates constitutional provisions for the separation of church and state.

Randall Wilson, legal director of the Iowa ACLU, denounced the program as a taxpayer-funded subsidy to Christian schools.

“That’s not neutral,” he said. “That’s favoring some religious schools over other alternatives.”

As for tax supporters’ promise that it would save the state money, the logic seemed simple:  if more parents could afford private school tuition, more children would attend private schools. This would translate into savings for the state as it would have to pay to educate fewer children.

However, enrollment has continued to fall in private schools. Private school advocates acknowledge that they lack comprehensive statistics showing how many students, spurred by the scholarships, have either switched from public to private schools or were able to remain in the private school.

But they point to anecdotes from parents saying the tuition grants prompted them to enroll or remain in private schools despite tight budgets. But even using those stories, it is hard to calculate the precise effect of the tax credit on private school enrollment.

No evidence of effects

The Alaimo family could star in one of those anecdotes.

Shelby Smith, 17, has literally followed in her mother’s footsteps. She spent kindergarten through eighth grade walking the halls of St. Pius X Catholic School in Urbandale, and is now gearing up for her senior year at Dowling Catholic High. And when she strolls across stage in a white cap and gown to receive her diploma this May, she’ll have completed thirteen years of Catholic schooling.

Her education has cost her family thousands of dollars – “a big chunk” of their income, says her mother, Brenda Smith-Alaimo. “But it was worth every penny that we’ve spent.”

She described “wonderful teachers” and “small class sizes” as primary perks of the local private schools.

And if it weren’t for scholarship aid, Brenda, a food service worker at St. Pius, said that she and her husband Jeff, an information technology worker with Principal Financial Group may have had trouble footing the tuition bills for Shelby and her three siblings – Morgan, a fourth grader, and twins Aden and Matthew, first graders at St. Pius.

“We cut back as much as we could, and we were at a point were we were considering Johnston or Urbandale,” she said.

But Catholic Tuition Organization stepped in with tuition grants.  Last year the organization paid about half of the family’s combined $10,700 tuition bill– part of the $1.23 million in scholarships it doled out to students enrolled in Des Moines area catholic schools in 2009.

“This is a phenomenal program because it gets the money to families who need it most,” said Kim Dreyer, president of Heart of Iowa School Tuition Organization, which granted 128 scholarships last year to students at seven Des Moines area Christian schools.

But before the birth of the program, Smith-Alaimo kept her oldest daughter enrolled in St. Pius “even though it was very difficult to make ends meet,” she said, adding, “I know that we could have more, we could do more,” without the financial burden of tuition bills.

Unlike a similar program in Georgia, Iowa’s law does not mandate school tuition organizations to grant the taxpayer-funded scholarships only to students who would add to private school enrollment. The Georgia program requires scholarship recipients older than pre-school or kindergarten to have first tried public schools.

And because eligibility for the Iowa program extends into the middle class, many students likely would have attended private schools without the tax credit scholarships.

Under the legislation, eligible families include all who live at or below three times the federal poverty level: $66,150 for a family of four, about $7,000 less than the median income for that size of family. For the six-member Alaimo family, the cutoff would be $88,590 – about $24,000 more than the median income.

Statistics on how much grant money goes to those at or below the poverty level compared to those above it were not available. But a 2009 Catholic Tuition Organization report estimated that the average family receiving its scholarships had between four and five members and an income of $52,857.

Although they lack complete statistics, several representatives of school tuition organizations say that the program has helped curtail the exodus of private school students.

Dreyer said many students have transferred from public schools to Heart of Iowa schools as families begin to afford tuition.  “[The tax credit program] has stabilized a portion of enrollment at our schools that was very volatile.”

Additionally, Davenport area private schools have seen an increase in enrollment, said Sara Eide, education outreach and development coordinator for Iowa Alliance for Choice in Education.

But overall, enrollment continues to fall.

Falling enrollment

Supporters of the incentive hoped it would stem a steady decline in private school enrollment that started over three decades ago. But that hasn’t happened.

From 1972 to 2001, the percentage of all Iowa students enrolled in private schools fell from 9.3 to 7.67 percent, according to enrollment data provided by the Department of Education. And by the 2006-07, the last year before legislation took effect, that number further dwindled to 6.63 percent.

In the three years the tax credit scholarships have been available, private school enrollment continued to fall, but at a slightly slower rate. Last year, private school students made up 6.59 percent of total state enrollment.

As private schools continue to lose students the main argument of tax credit supporters “doesn’t seem to be holding water,” Bolkcom said.

Not only does the state lack hard evidence to show the program is working, it also has few tools to ensure it isn’t abused.

Little Oversight

There has been no documented abuse of Iowa’s private school tax credit program. Although key provisions of Iowa’s program were meant to prevent misuse of the program, the state doesn’t check to see that many of those rules are followed.

Last fall, two Arizona newspapers, The Arizona Republic and the East Valley Tribune, chronicled years of abuse and inefficiency in Arizona’s private school tax credit program.  The papers reported that parents of private school students were receiving tax credits for donations towards their own child’s scholarship. Also, the news accounts said school tuition organizations distributed most scholarships to high income families and used much of their revenue on large salaries, luxury cars, and expensive real estate for staff members.

Such abuse probably isn’t happening in Iowa, said McNulty, the program manager at the Iowa Department of Revenue.

Nevertheless, he acknowledged that the state has few oversight tools.

“This gets into the broader issue of accountability,” he said. “Tax return information is kept confidential and that’s been an issue in the legislature to provide…more sunshine on who’s getting these tax benefits.”

Under the law, the Department of Revenue oversees the distribution of tax credits to donors, while making sure school tuition organizations spend at least 90 percent of their revenue on scholarships, leaving the rest for administrative costs. But the law does not give the Department of Revenue many ways to ensure compliance with other provisions.

For example, the law does not require STOs to submit information about the families of scholarships recipients, thus obstructing the department’s ability see whether the tuition scholarships are going to the right people.

“There is no way to currently determine that the children of taxpayers who claim the tax credit do not benefit from scholarships,” said a 2009 Department of Revenue report.

Moreover, the state cannot ensure that scholarships are going to low and moderate income families as the law requires.

Officials of some school tuition organizations say they use independent firms to provide a measure of accountability. Such firms analyze finances of scholarship applicants and determine how best to distribute the grants to eligible people.

“I honestly think [tuition organizations] are doing the right thing, and I’m certainly not aware of any wrong doing…,” said McNulty, who routinely fields their questions when tax filing deadlines approach.

But the state should get lists of scholarship recipients, he said, “to make absolutely sure that STOs are doing what the law intends that they do.”

Mike Owen, assistant director of the Iowa Policy Project, a non-partisan think tank in Mount Vernon, described the lack of analysis of the school tuition tax credit as “not unusual.”

“Iowa tax credits are not routinely reviewed, but are on autopilot, and the Legislature for many years has permitted this to continue,” he said. “It could be argued that only with a sunset will [tax] breaks such as the STO undergo regular scrutiny.”

That was one recommendation of the Culver’s tax credit panel in January– a five year sunset clause for all credits.  The legislature rejected it.

The panel also recommended lowering the amount in tuition tax credits statewide to $5 million and decreasing credits to 40 percent of each contribution, which would bring in $12.5 million in donations if fully awarded.

A tax reform bill passed in the Senate included lowering the program’s cap by 10 percent, reducing the program in proportion with a slew of other programs, including public schools, healthcare, and public safety. But the House stripped those recommendations from the bill.

“Every one of those credits has a constituency,” said Bolkcom. “As you find out in the legislature, when you spend money, different groups want you to keep spending that money, and this was just an example of that by private schools.”

As for questions on the law’s constitutionality, Wilson said the ACLU is awaiting the Supreme Court’s ruling on the Arizona case before challenging the Iowa law, but the group is “not above” going back to the legislature and urging them to “do the right thing.”

And if the Arizona ruling goes against tuition tax credits, the ACLU might still go to the legislature before filing a suit.  The final option would be legal action, he said.

Jeanne Wells, executive director of Catholic Tuition Organization, said she’ll be watching the case too. And if the law is ruled unconstitutional: “it could be devastating.”

(Joyce Russell is an IPR reporter who covers state government out of the Des Moines office. Jim Malewitz is an IowaWatch staff writer and a master’s professional journalism student specializing in non-profit journalism at the University of Iowa.  Email Jim at
jim-malewitz@iowawatch.org.)

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