Excessive Regulation and the Law of Unintended Consequences

It goes without saying that we all want students to succeed academically. In private school choice programs, however, policymakers must be especially cautious not to inadvertently harm students by overregulating in the name of ensuring school quality. Corey DeAngelis, a policy analyst at the Cato Institute, reminds us of this paradox in a column for the Washington Examiner.

Most private parental choice programs require that scholarship students take at least one norm-referenced assessment per year to track academic performance. In some cases, like Florida, results of these tests are compiled, analyzed, and reported publicly. This type of arrangement ensures that schools evaluate students’ progress each year and that state officials can see how well the program is meeting those students’ academic needs.

Sometimes, though, elected officials decide that heavier regulation is needed to “ensure quality.” By tightening standards and restrictions, they reason, the state can prevent disadvantaged families from picking bad schools. For instance, policymakers can force state testing in private schools, modify admissions policies, require that every teacher hold a state license, or set other restrictions for participating private schools.

But is this approach effective? No, for one very important and often overlooked reason: Private schools do not have to participate in choice programs. If a private school is already successful and financially stable outside of a scholarship program, its leaders may well decide that the additional regulation is not worth the extra revenue. Less stable schools, on the other hand, may not have the luxury of declining that revenue.

This theory is supported by DeAngelis’s recent study on heavily regulated choice programs in Milwauke and Ohio, in which he finds that high levels of regulation lead better-rated and more expensive schools to decline participation at a higher rate than other private schools. These findings mirror those of an earlier study using similar methods to examine private school participation in Washington, D.C., Indiana, and Louisiana.

Encouraging stable, successful schools not to participate while incentivizing less stable schools to take the plunge can result in a supply of schools skewed heavily toward the lower end of the performance spectrum. And, naturally, such a skewed supply of schools can severely impact student performance.

The first negative results ever found in an American private school choice program emerged in 2015 from Louisiana’s voucher program (notably distinct from the Tuition Donation Credit Program, in which ACE participates). When researchers dug deeper, they found that in Louisiana’s program, which boasts some of the heaviest regulation in the country, participating private schools tended to have low tuition and declining enrollment—both signs of schools in distress. Roughly two-thirds of the state’s private schools choose to stay away from the program, presumably because they can afford to do so.

The evidence seems clear: We cannot regulate our way to higher-quality schools in private school choice programs. We can, however, do whatever we can to incentivize successful private schools to participate in these programs and trust parents to make the right decisions for their children.

Explaining the IRS Proposed Rule on Charitable Contribution Deductions

On August 23, the IRS issued a long-awaited proposed rule on federal charitable contribution deductions under state tax credit programs. The rule was originally intended to address schemes in high-tax states to circumvent new federal restrictions on the deductibility of state and local taxes (SALT). So, how did it come to affect private school choice programs? And what happens next?

The Tax Cuts and Jobs Act, passed in late 2017, limited the amount of state and local taxes taxpayers can deduct each year to $10,000. Unsurprisingly, this new cap caused a fair amount of consternation among high-wealth individuals who could no longer deduct the full amount of their state and local taxes from their federal tax bill.

In response, several states—New York, Connecticut, and New Jersey—set up government-run “charities” that allowed taxpayers to make payments in lieu of taxes. These taxpayers received state tax credits for their gifts in addition to a federal charitable contribution deduction, effectively allowing them to preserve their tax breaks despite the SALT cap.

Meanwhile, it became clear that the imposition of the SALT cap messed with tax formulas in way that allowed some donors to receive tax benefits in excess of their contributions when those donors claimed both a state tax credit and a federal deduction for the same gift. Opponents of school choice wasted no time capitalizing on the issue, writing letters (and even full-length white papers) arguing that the IRS should write any rule addressing SALT cap workaround schemes broadly enough to also include scholarship tax credit programs.

Unfortunately, that is exactly what the agency did. U.S. Secretary of the Treasury Steve Mnuchin issued a (very) carefully worded statement implying that the rule was designed not to impact state school choice programs. But while technically accurate in its statistics, that statement was misleading; the rule does indeed affect scholarship tax credit programs like the ones in which ACE participates in Kansas and Louisiana.

With only a few exceptions, the IRS rule means that donors will no longer be able to claim a state tax credit and a federal deduction for the same gift. This restriction applies across the board, impacting conservation, historical preservation, medical, and other credits in addition to school choice programs.

So, what happens now? First comes a 45-day public comment period, which closes on October 11, followed by a public hearing on November 5. Additional rounds of review by federal agencies will follow. If approved in its current form, the rule’s new restrictions would retroactively apply to donations made on or after August 28, 2018.

National school choice groups have taken different positions on the rule, with some arguing that full federal deductions should be preserved and others supporting the substance of the rule while asking for a delayed effective date.

ACE Scholarships is following this issue closely and will be participating in the public comment process on behalf of our Louisiana and Kansas scholarship families. Stay tuned for more on that front.