Over the last decade, the state of Arizona has made ground-breaking attempts at K-12 education reform.  A 1997 law allowing taxpayers to steer a portion of their state income-tax liability toward a student at a private school now provides significant scholarship aid each year to 22,500 of the 54,000 students enrolled in private schools.  With over one million of Arizona’s students still in public schools, however, the results of the movement are difficult to measure.

Incorporated by the state and regulated by the federal government’s 501(c)3 tax-exemption rules, School Tuition Organizations (STOs) have thrived and multiplied into a battalion of 54 organized nonprofit businesses in less than a decade.  Unlike vouchers or government subsidies for low-income families, privately run nonprofit STOs solicit their own donors, rather than rely on a handout from the state.  Before they can fund a single child’s scholarship, they have to persuade individual donors to make a significant contribution and to take a credit on next year’s taxes, which is no simple task.

What began in 1997 as a $500 tax credit has now grown to a maximum of $1,000 per year, which a taxpayer can donate to the organization of his choice, then take as a dollar-for-dollar credit against his state income-tax liability.  (Arizonans have five years to apply the credit to their state tax bill.)  In 2005, almost 70,000 taxpayers made donations, but, with almost 2.5 million individual income-tax returns filed statewide, that represents fewer than three percent of taxpayers.  There’s plenty of room to grow.

By law, each STO must turn at least 90 percent of the funds it collects into scholarships for students.  Beyond that, STOs market themselves in a variety of ways—from need-based scholarships to those based on a student’s academic merit (regardless of family income) to any combination of community service or academic criteria.  And most, if not every, private school has now either contracted with an STO or created its own.  That marriage of fundraising, fund distributing, and the delivery of benefits to the schools and their families has created an economically and politically powerful group of tax-credit advocates.  And like all advocacy groups, they have a desire to protect their entitlement—for their own schools, their own children, and their own tax dollars.

This, in turn, creates an atmosphere of accountability for the ultimate disposition of the funds.  It also boosts efficiency, because the donation does not pass through the state treasury.  STOs are actually private corporations governed by a board of directors, often parents or grandparents who are likely to have been active in the school-choice movement.

Most STOs allow the donor to recommend that a scholarship recipient be some deserving student at a particular school.  Some even allow a donor to recommend an individual student by name, as long as he is not the donor’s dependent.  In fact, if a donor wants his donation to be used for Native Americans, single-parent families, or families with a large number of children, there are a number of organizations that are happy to fulfill his wish.  Rather than creating an unnecessary layer of government-regulated administrative bureaucracy, the law actually stimulates competition among organizations for each donor.

Naturally, among the first institutions to market the tax credit and create STOs were the Catholic schools in the dioceses of Phoenix and Tucson and multiple-campus religious schools.  These professional educators already had an enterprise in place to take advantage of the opportunity to finance their students’ tuition bills.  This was an instant financial boost to those organizations that were funding scholarships based on need.  Now, pastors and principals no longer have to distribute a limited amount of tuition waivers to poor families, and bishops need not redistribute income from wealthy parish schools to poor ones.  Families need only to apply to the STO, submit a financial statement and tax return, and receive an award based on objective financial need.

Next in line came the more esoteric private schools, including homeschooling co-op groups who simply turned to their handful of existing parents for donations, essentially turning their own tax dollars into scholarships for their own children.

Overall, however, after nearly a decade, the private-school market has not yet responded to the new money coming in from STOs.  The money has gone not to help build new private schools but to fund tuition for students already in private-school classrooms.  In fact, few private schools in the Phoenix area even have openings for new students.  That’s partly the result of the introduction of charter schools, which receive state funds for operational needs but need to beg or borrow for capital and classroom space.

One factor that may explain the lackluster effects of the STOs is Arizona’s record-setting population growth over the last ten years.  Students are not moving from school to school, because there are enough students being imported to satiate all the schools, public or private.  Even with Arizona’s annual population growth rate of 3.5 percent for the last decade, few private schools have built new classroom space or opened new campuses.  Moreover, many schools just raised their tuition costs to respond to the supply of students and parents who are now able to pay a little more for tuition, thanks to the extra help from STOs.  Some schools explain to parents who balk at the increase that they should simply apply for scholarships and encourage others to make tax-credit donations to fund them.

When the income-tax-credit law was passed, there seemed to be as many different reasons given to support it as there were legislators who voted for it.  Overall, there were five: It would help some poor kids to gain access to private schools; it would help middle-class parents better afford a better education; it would create a larger supply of students competing to attend private schools; it would pressure public schools to be more competitive; and it would provide a just way to reimburse parents for putting their children in private schools that would not burden the taxpayers.  Having watched this particular legislative process, I am amazed that courts try to intuit and interpret “legislative intent” when deciding the application of the law.

Nonetheless, the tax-credit policy has survived numerous lawsuits and a substantive challenge before the U.S. Supreme Court.  These victories have emboldened supporters, who have begun chasing additional targets through the state legislature.  Up for reelection, besieged Gov. Janet Napolitano reluctantly signed into law this spring the second generation of tuition tax credits: a corporate-income-tax credit modeled after the tax credit for individuals.  Though crippled by a ten-million-dollar annual cap, a five-year sunset clause, and restrictions that require the funds to be distributed to low-income families, this new scholarship vehicle also carries an interesting requirement: The funds can only be used for “switchers”—students moving from public schools to private ones.  The signing concession from the governor may have been a Pyrrhic victory, because it came at the price of new spending to create statewide all-day kindergarten in public schools.  To many families, the change may mean nothing more than new state-subsidized daycare.  But to those families wrestling with the decision to send their children to private school, it may push them back toward the marginally more economical public school.

While it may not be the intended effect of the legislation, an entrepreneurial private school can now take advantage of the dedicated revenue stream from the second-generation tax credit to build new classrooms, filling them with students from any number of nearby public schools.

The original tuition tax-credit program still has not come close to meeting the demand for scholarships for existing students in private schools.  On average, private-school tuition in Arizona is $4,000, while the scholarship based on the tax credit is only $1,400.  Only when that demand is met, or when the fruits of the corporate-income-tax-credit policy are handed to those switching from public to private school, will the enrollment numbers of private schools increase.

How high will private-school tuition go, as a result of the taxpayer-funded increase in potential customers?  Government-run schools in Arizona now spend $8,500 per child on physical construction and actual operations combined; private schools spend half of that amount.  Legal mandates, unions that pay teachers the same wage regardless of performance, and bureaucratic nonparent regulators are always going to keep public-school costs above those of private schools.

Still, even if no public-school student ever switches to a private school, the scholarships based on the tuition tax credit will help dull the financial pain felt by private-school parents.  However, dulling the financial pain could also dull the motivation of parents to regulate their child’s school.  If a private education becomes nearly free, will parents who had been responsible for the success of their children in school now be afraid to look the gift horse in the mouth?

In 2005, the total amount of scholarships paid by 54 STOs was $31 million.  That is but a grain of sand on the beach when half of the ten-billion-dollar state budget is spent on K-12 public education.  But that grain of sand is a foreign object in the eye of a typical advocate for public-school spending in Arizona, who is irritated by the fact that private-school success is diminishing the effectiveness of their demands for more public-school funding, less accountability to parents and taxpayers, and greater authority over the education of children in the state of Arizona.  For that alone, it may be worth the hassle.