New tax subsidies proposed by Senate Finance Committee Chairman Bill Roth (R-Del.) would turn public schools into tax shelters for the wealthy and offer new subsidies for parents whose children attend private schools--with much larger subsidies for better-off families than for others.

The Roth plan, which is being marked up by the Finance Committee today, includes numerous other tax-based spending initiatives, generally with similar themes.

"With his long experience on the Finance Committee, Senator Roth must understand that special tax exemptions and tax shelters are much more valuable to well-off people than to average families," said Robert S. McIntyre, director of Citizens for Tax Justice. "Maybe that's why he has consistently supported such 'upside-down' subsidies throughout his career."

1. Tax-shelter benefits to private owners of public schools. Roth's proposal would allow individual investors and corporations to issue tax-exempt bonds to finance the construction of public schools. The privately-owned schools would be leased to local governments for public use. The apparent rationale for this proposal is to help localities build more public schools. In reality, however, it would provide little benefit to local governments, while creating significant new tax-sheltering activities for wealthy investors.

Here's the tax-shelter arithmetic: In the case of a publicly-owned school, the local government pays the annual costs of interest and upkeep on behalf of the public. If the school is privately owned, the local government would logically be willing to pay no more than an equivalent amount in rent to the private owners for the public use of the school. But private investors generally can't build and maintain schools as cheaply as local governments can, because the governments can issue tax-exempt bonds and enjoy lower interest costs.

But if the private investors are allowed to issue tax-free bonds, as Roth proposes, then their pretax costs can be similar to, or even a bit lower than, the costs that a local government faces. So the investors may be able to charge the local government an attractive-looking rent for the use of the school.

So localities may save a little on school construction costs. But the private investors will get much more--even though the leasing deals may show very little profit for the investors before taxes. That's because the investors' real profit will come from tax sheltering.

Specifically, unlike public owners of schools, the private investors will be allowed to take depreciation write-offs. These will generate tax "losses" that can be used to reduce their federal (and state) income taxes on other, otherwise taxable income.⁽¹⁾

In other words, under Roth's proposal, privately-owned public schools would function as big real-estate tax shelters for their well-off investors.

"From both tax policy and cost considerations, turning public schools into tax shelters for the wealthy in order to give local governments at best modest savings doesn't seem to be something that the federal tax laws should promote," McIntyre said.

2. Expanded "upside-down" subsidies for private schooling: Current law provides tax subsidies for parents who can afford to set aside up to $500 a year for each of their children to pay college expenses. (The money goes into special education savings accounts, officially called "education individual retirement accounts.") The income generated by the accounts is tax-free so long as it is eventually used to pay college expenses. Thus, the subsidy level is dependent on both a family's ability to save and on its tax bracket. Even with equivalent education savings, for example, a 28% bracket family will get almost double the subsidy of a 15% bracket family. (At very high income levels, the subsidy is unavailable.)

Roth's proposal would increase the limit on annual contributions to education accounts to $2,000 per child per year and extend eligibility to parents paying to send their children to private and religious elementary and secondary schools or who have home-schooling expenses. (The proposal would nominally affect contributions in 2000-03 only, but once the law is changed, there will be significant pressure to extend it past 2003.)

"In other words," McIntyre said, "Roth would quadruple the maximum possible subsidy and tilt it even more in favor of higher-income families who have more disposable income available to save and who are much more likely to send their children to private elementary and secondary schools."

"Programs like these would never see the light of day if they were thought of as part of the regular budget," McIntyre said. "They shouldn't receive any less derision just because Senator Roth wants the Internal Revenue Service to administer them."

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1. In tax jargon, because these public school projects will be mostly debt-financed, the effective federal income tax rate on the projects will typically be "negative." That is, they will be more profitable after tax than before tax.