Should the Charitable Tax Deduction Exist?

Print Share on LinkedIn More

June 9, 2012; Source: The Economist

When The Economist starts to closely examine the justifications for a tax deduction for gifts to charity—whether in the U.S. or in the U.K.—the issue of the charitable deduction is no longer sacrosanct. President Obama’s proposal to cap the charitable deductions (and all other itemized deductions, such as the mortgage interest deduction) at 28 percent has gone absolutely nowhere, greeted with just about complete silence by members of his own party in Congress. In the U.K., Chancellor of the Exchequer George Osborne withdrew his proposal to limit tax relief for wealthy British taxpayers in the wake of vocal opposition from Tory backbenchers.

One might think that the issue is basically much ado about nothing, except that Independent Sector’s Diana Aviv told The Economist, “I’m expecting a big fight in Congress over charitable deductions and over the definition of charity. I’m very concerned.” Aviv also bemoaned the increasingly popular practice of local and state governments exacting taxes from tax-exempt property owners under the guise of “payments in lieu of taxes.”

It’s hard to imagine that the Conservative/Liberal coalition government of Prime Minister David Cameron is really populated by raving populists. The same is true for President Obama’s administration, which has maintained strong relationships with banking and other corporate executives, not to mention the stalwart corporate defense role played by Treasury Secretary Tim Geithner. However, it may be that tax subsidies that are basically the province of wealthy taxpayers are under attack as part of an international populist uprising against the top one percent. Tax subsidies for the charitable donations of the rich may not be immune, despite the lessons of the public beatdown that Osborne took from members of his own party.

The Economist suggests that the cost of tax subsidies for donors to charity in the U.K. is about $5.5 billion in U.S. dollars. In the U.S., the tax deductions cost $39.6 billion in 2012, and that is expected to rise to $51.6 billion in 2014, according to the U.S. Treasury. Those are big but not unfathomable numbers (no match for, say, the cost of U.S. war efforts in Afghanistan and Iraq). Nonetheless, The Economist is the latest and perhaps most influential source raising questions about why government should subsidize the charitable giving of the wealthy, or, in its recounting of a similar British debate in the 1800s, “why should taxpayer B face a bigger tax bill because taxpayer A chooses to give to charity?”

The basic issues, articulated by The Economist and others, are these:

  1. Can charities show that the value of the benefits delivered by nonprofits exceeds the cost of the tax revenues forgone by government as a result of the tax deduction? The problem is that there are a huge number of types of charities that have greater or lesser degrees of societal value. How would this kind of calculation be done?
  2. Does the charitable deduction or some other tax incentive for charitable giving affect the willingness of taxpayers to give to charity or how much taxpayers are willing to give? Increasingly for the wealthy, the studies seem to indicate that tax subsidies affect the size and timing of specific grants, but not so much the willingness to give.
  3. Should lower income donors have to bear the costs of supporting social justice-oriented charities and simultaneously pay higher government taxes as a result of higher income taxpayers’ taking advantage of tax deductions? Despite protestations from American charity leaders, some charitable incentives (such as the IRA rollover) don’t do as much for charities serving the poor as they do for nonprofits, such as universities and museums, which tend to benefit upper income users.
  4. Given that British and American charities have major functions as deliverers of government programs, should tax deductions for charitable gifts be part of the revenue streams of nonprofits above and beyond what they get as federal, state, and local government contract payments?
  5. Unlike direct government funding, charitable giving to nonprofits is a sort of public-private partnership, with the eyes of donors large and small keeping track of the performance of the charities they support. Does charitable giving increase the accountability of nonprofits above what government-supported charities do to live up to their roles and mandates? Or do donors induce and support the kind of risk-taking and experimentation that governmental funding sources cannot and will not?
  6. “Hybrid” forms of organizations such as low profit limited liability corporations (L3Cs) and “B corporations” are making the case for the role of the for-profit sector in meeting and solving social problems. The Economist asks, “Is (there) a risk that subsidised charitable service-providers may be squeezing out innovative for-profit alternatives?”
  7. Does it make any sense to provide a deduction for charitable giving when as much as half of individual charitable giving goes to religious organizations? The Economist describes some of charitable giving to churches and synagogues as akin to a membership fee. Should the tax structure incentivize and subsidize the membership costs for joining exclusive religious clubs?
  8. Three-fourths of the value of charitable deductions goes to donors with more than $500,000 in annual income, though they account for slightly more than half of all charitable donations. Is it fair for all taxpayers to be subsidizing the charitable giving of the very rich?
  9. The Economist points out that there is a public benefit test for charities in the U.K. but much less stringent requirements for qualifying for 501(c)(3) status in the U.S. Others suggest that, at least in the past, to become a 501(c)(3) in the U.S. was a simple process with few hurdles. Simply because they share a tax status, are all charities equally deserving of equally valued charitable dollars?

The Economist concludes, “Most experts on charity reckon the status quo to be the least-bad option… It may offend some that people are as keen to give to donkey sanctuaries as to shelters for victims of domestic abuse. But, as Patrick Rooney of the University of Indiana asks: ‘Who has the wisdom to decide what is a good charity?’” But Stanford professor Rob Reich thinks it might be more appropriate to use the tax code to incentivize charitable giving to “the more useful sorts of charity, especially those focused on reducing poverty.”

Where do NPQ Newswire readers come out on these issues?—Rick Cohen

  • Loretta Prescott

    Eliminating the charitable tax deduction will kill off thousands of valued community organizations doing the work the government cannot and should not do. As the mindset in Washington changes, and less government funding is available to charities comprising the safety net in hundreds of thousands of communities across the country, the very least the government can do is to retain the ability of those who give to write off their contributions. This has nothing to do with whether the donor is rich or poor. charities need support, the rich can support them, the government needs to make that easy to do or its people will see dire consequences when the nonprofits providing the services shut down.

  • George Richmond

    Given that religious organizations receive much of the donations, it is virtually impossible to end the tax credit for donating to charities. With education and medicine also large recipients, how can the tax laws be changed in the United States?

    The Congress of the United States has created for individuals a very complicated and politically driven tax code which has driven about 80% of the individual tax filers to accountants or tax soft ware to complete the preparation of their returns.

    So, for Congress to take on the challenge of eliminating charitable contributions, the Sun will have to rise in the West and set in the North.

  • Lee O’Neill

    The Economist approaches the issue from the perspective of the effect on taxpayers and tax collectors but the subsidization is of the charities. An alternative way of looking at the problem is that tax deductible donations are a way to collectively pay for work that we don’t want the government to do.

    There is a problem, though, with many of the institutions being subsidized. The Economist questions religious organizations but that only touches the surface. What is the justification for treating hospitals and colleges/universities as charities, the same type of legal status as food banks, legal aid societies, or homeless assistance organizations?

  • Ron Wormser

    The charitable tax deduction is one way by which society as a whole intentionally nurtures traditionally ‘do good’ organizations. Exemption from certain taxes (income, property and sales taxes being the most significant) is another way. These tools have been put to use on the premise and promise that the society as a whole benefits from the efforts supported.

    Simply because there have been and always will be indisputable, sometimes egregious examples of abuses by both tax payers and by nurtured organizations, misdeeds by a small minority are insufficient reason to negate the vastly larger benefits afforded both those who support and those who benefit from the work performed.

    There is – I think – no dispute that the do good sector has expanded considerably over the years reflecting both a broader and a deeper array of social needs and an increase of those persons and corporations willing and able to support the work.

    Bottom line: so long as the overwhelming majority of the nurtured organizations are delivering the goods, are upholding their end of the bargain – to do good in ways that benefit the society, then surely the society should continue to uphold its end of the bargain.

  • rick cohen

    Hi Loretta: But the big debate question is exactly how much the charitable deduction incentivizes giving, how much it works differentially for different classes of taxpayers, and, viz-a-vis your point, whether the deduction works effectively for those thousands of smaller community organizations as opposed to big charities. Thanks for writing.

  • rick cohen

    Hi George. thanks for your comment. When Congress takes on tax reform, do you think that its agenda will be the elimination of the charitable deduction or its modification? Even with that, I like your comment about where the sun might rise and set for Congress to act, even if it concerns a modification of the deduction. So far, Congress hasn’t been able to get anywhere near tax reform and has shown no appetite at all for examining different approaches to the charitable deduction. I’m looking at the sun rising in the west right now. Thanks for your comment.

  • Krystofer Meadows

    Between 1915 and 1917 Congress enacted a series of provisions that have formed the basis of the federal income tax systems as we know it today. Charitable tax deductions were initiated because there was considerable concern that the increased tax rates to fund WWI would cause philanthropic individuals to reduce their donations to charitable organizations.

    The charitable tax deduction and the tax exempt status of charitable organizations are the two underlying factors that form the relationship between tax policy makers and nonprofit organizations. Some believe that charitable tax deductions provide an incentive to give. Others think that there should be less emphasis on tax deductions and greater attention paid to developing a more straightforward and equitable tax system.

    Legislative reform on charitable tax deductions tend to focus on tax abuse concerns. However, charitable tax reform is also a format to identify possible sources for additional tax revenue to help close the gap between uncollected tax and the amount of tax that would be collected if taxpayers paid the proper amount that they owed.

    Charles T. Clotfelter, author of “Federal Tax Policy and Charitable Giving” concludes: “The United States is distinctive among Western countries in its reliance on nonprofit institutions to perform major social functions. This reliance is rooted in American history and is fostered by federal tax provisions for charitable giving. This study has demonstrated that changes in tax policy–affected through legislation or inflation–can have a significant impact on the level and composition of giving. As long as the nonprofit sector retains its important role in the United States, understanding the effect of the tax structure on charitable giving will be an essential part of the study of public policy in education, health, and many areas of social welfare. Whether or not taxes are an explicit part of policy in any of these areas, tax are certainly an important implicit component.”

  • Jack Shakely

    The idea of government subsidies to wealthy charitable donors, especially donors to religion, is worthy of discussion.
    But the idea that some charities are more worthy of subsidies than other is sheer madness.

    And with due apologies to Diana Aviv and INDEPENDENT SECTOR, the next session of congress will have too many other fish to fry to deal with the charitable tax deduction. That doesn’t mean we shouldn’t discuss and research it. Any subject that must rely on a 1985 study by Charles Clotfelter is in serious need of objective study.

    The charitable tax deduction has been around since 1913 based on the premise that it provides an incentive to gifts to charity. Does it? History would indicate that it neither helps nor hinders giving; it just costs billions of taxpayer dollars.