Replicating the Harlem Children's Zone: How a Charter School Tax Credit Could Bring Human Capital Investment to Scale

Every year, 1.2 million students drop out of high school in the United States. A clear moral and policy failure, this ongoing crisis is also an economic disaster. Over their lifetimes, dropouts cost the government, on average, $292,000 in lost tax revenue, public assistance and incarceration expense, and earn $700,000 less than they would with a diploma. The dropout problem is particularly acute in low-income communities, where it is six times more common than in middle- and upper-income communities. This perpetuates income inequality and has caused U.S. Education Secretary Arne Duncan to declare that "education is our path out of poverty."

Charter Schools as a Solution

Some communities have turned to charter schools to address the academic achievement gap. By design, charter schools are public schools that operate outside the normal public school governance structure and have the freedom to experiment with many aspects of the education delivery model.

There are currently more than 4,900 charter schools serving 1.6 million children in 39 states. These charters take a variety of forms; many incorporate novel education elements in their curricula and provide wrap-around social services as needed.

Among the most well-known charter schools are those operated by the Harlem Children's Zone (HCZ), which takes a more holistic approach to education. Named "one of the biggest social experiments of our time" by Paul Tough at The New York Times, the HCZ provides program participants with a continual pipeline of reinforcing social and educational services throughout childhood. The pipeline begins with Baby College, targeting children up to age 3, and continues with in-school, after-school, social-service, health and community-building programs.

Successful charters, like those run by the HCZ, differ dramatically in type and approach. Accordingly, it is difficult to identify a single or combination of variables in any one charter that, if replicated, would produce the same results across the public school system. As a result, a number of promising strategies have simply become one-off success stories. This inability to deliver replicable innovation has locked the charter movement in a perpetual cycle of experimentation which, in turn, has led to policy inertia. A new policy approach is needed; specifically, one that can scale success without sacrificing innovation.

A Model that Works: The Low Income Housing Tax Credit

Such a policy approach already exists in the affordable housing field. Passed as part of the Tax Reform Act of 1986, the Low Income Housing Tax Credit (LIHTC) is a dollar-for-dollar investment tax credit (one dollar of tax credits reduces one dollar of tax liability) designed to fund the construction and rehabilitation of affordable, multifamily rental housing. The credit, which acts as a "coupon" for future taxes owed, is allocated to state authorities on a per capita basis and awarded to affordable housing developers according to a scoring system that takes project viability and social impact into account. If awarded a tax credit allocation, developers sell the credits to investors (mostly corporations) in exchange for project equity. The credits are sold at market value based on a range of factors, including credit recapture risk. Recapture occurs when a project falls out of compliance at any point in the first 15 years of its operation, resulting in a significant financial loss to its investors. Compliance is tied directly to project completion, financial viability and ongoing rent affordability.

The LIHTC program is instructive because it demonstrates how the federal government can successfully bring its substantial financial resources to bear on a decentralized, locally based system of service providers. A similar policy tool could be used to grow a network of high-achieving, high-poverty charter schools capable of meeting the individual needs of a diverse set of disadvantaged students.

Charter School Tax Credit

A charter school tax credit would function much like the LIHTC. Credits would be allocated to the states, which, in turn, would award them to high-performing charter schools. Upon receiving the credits, schools would sell them to private investors and use the proceeds to fund wrap-around services or intensive classroom-based initiatives. The price paid for the credits would be based on the investor's level of confidence that those services and initiatives will deliver the academic results necessary to stay in program compliance and avoid credit recapture. Compliance requirements would be specific, measurable goals demonstrating low-income student achievement. These standards would have the dual benefit of allowing the government to monitor improvement while also allowing the school to evaluate its own programs and adjust them as needed.

A charter school tax credit would also ensure that every dollar spent on the program is tied directly to a positive, measurable education outcome. This is a significant improvement over the status quo—investing in schools on the basis of past performance or future promise, with no recourse should those assessments prove to be wrong. This is particularly important during periods of fiscal austerity. In commenting about the LIHTC in 1992, the Los Angeles Times argued that the tax credit "forms the cornerstone of the numerous public/private partnerships that are increasingly the salvation of cash-short cities and states." Today, as in 1992, budget deficits are leading to social program cuts. As policymakers seek to balance their budgets going forward, a charter school tax credit program could offer a fiscally responsible method of funding human capital development because funding would only flow to schools that work.

A charter school tax credit program would also raise private capital to directly support education, a critical need in impoverished school districts. High-poverty public school districts receive, on average, $773 less per student, per year, than low-poverty districts. Meanwhile, the schools operating in these districts face significant poverty-related challenges that their low-poverty counterparts do not face. At a minimum, these schools should receive funding parity and, arguably, supplementary funds as well. A charter school tax credit would deliver these funds, allowing schools to meet local needs and deliver customized educational services contingent on their ability to remain in program compliance.

There may be ancillary benefits to a charter school tax credit as well. Low-income student performance is influenced by a host of factors, many outside the direct purview of school. As a result, investors may find complementary community investments to be an effective way to protect their tax credit investment. These investments, combined with the funds raised by the tax credit program, could be sufficient to transform entire neighborhoods, as the HCZ has done in New York City. A charter school tax credit may also increase the engagement of other stakeholders in the education process, including, among others, local businesses, universities, nonprofits and neighborhood residents. As with the LIHTC, a charter school tax credit would create a financial incentive to organize these community stakeholders and leverage their private information. It is also a way to engage them directly in a shared societal goal: better-equipped and more-productive workers and citizens.

Low-income students have unique needs, both academically and socially, and schools that serve these students need the operational flexibility to meet them. Likewise, the funding streams that support these schools should allow for adaptive use, contingent on success. A charter school tax credit program, by virtue of its built-in accountability checks, is the perfect vehicle to deliver this type of funding. Unlike direct expenditures, which are not recoverable, tax credits allow for experimentation without exposing the government to failure risk. This affords schools the freedom to address local needs without the often onerous, and potentially restrictive, oversight that comes with direct public funding.

This article is based on a working paper published by the Federal Reserve Bank of San Francisco in December 2010. To read the original paper and view citations, visit www.frbsf.org/community-development/publications/working-papers/.