Next in the sequence of fiscal cliff standoffs is the renewal of the continuing budget resolution, which keeps the federal government running in the absence of an approved federal budget. That’s supposed to happen by March 27th, or else the government almost grinds to a halt but for certain essential services. Our guess is that, rather than facing a shutdown after the fiscal cliff and the sequester, both sides will find some way to keep the machinery of the federal government humming. A shutdown would lead the American public to believe that Congress can’t even collaborate to make so much as a pitcher of lemonade, which would make it hard for even the most feckless politicians to face their constituents.
If government extends the continuing resolution, as we expect it will, what effect might that have on the negotiations between the White House and Congress in relation to sequestration? President Barack Obama has indicated that he will still push for new revenues. Does that mean President Obama will revive his proposal to cap the deductibility of charitable donations (and other itemized deductions) at 28 percent even though the top tax rate is now 39.6 percent? If that proposal were to resurface, would it have a prayer of passage, having gone nowhere in Congress four times running?
And where will the charitable deduction fit into the larger issue of maintaining federal government funding for charities that address the basic needs of lower income Americans? Here is our analysis of the short-term future of the charitable deduction, pro and con, based on the surprising and perplexing House Ways and Means Committee hearings that were convened to get charities to speak out on their incentive in the federal tax code.
Success in Advocacy on Retaining the Current Charitable Deduction
The president’s strategy going forward is predicated on raising new revenues through “closing loopholes.” To be sure, there are plenty of loopholes in the tax code, from the infamous production subsidies for oil companies to the “motorsport entertainment complex” incentive (the NASCAR tax break renewed in the fiscal cliff bill) to tax breaks for hedge fund managers and (President Obama’s oft-mentioned favorite) corporate jet deductions. But Obama and members of the House and Senate know that the big money isn’t in these “loopholes” but in other tax expenditures. According to the White House’s budget proposal estimates for 2013-2017, some of the biggest chunks of money denied the federal budget (not including expenditures for pensions and Social Security benefits) are these:
- Exclusion of employer contributions for medical insurance premiums and medical care: $1,012.23 billion
- Mortgage interest deduction on owner-occupied homes: $606.42 billion
- Exclusion of net imputed rental income: $337.38 billion
- Capital gains: $321.47 billion
- State and local taxes other than on owner-occupied homes: $295.05 billion
- Deductions of charitable contributions (other than education and health): $238.72 billion
- Exclusion of interest on public purpose state and local bonds: $227.5 billion
- Step-up basis of capital gains on death: $182.21 billion
- Capital gains exclusions on home sales: $171.11 billion
- Exclusion of interest on life insurance savings: $140.63 billion
- Deductibility of state and local property tax on owner-occupied homes: $140.63 billion
Are these all loopholes? What about the tax credit for child and dependent care, the low income housing tax credit or the lifetime learning tax credit? Are they loopholes? What about the deferral of income from foreign controlled corporations, the corporate tax credit for investment in “clean coal,” or the accelerated depreciation on equipment and machinery for corporate taxpayers?
When the president refers to loopholes that he would like to close, what, specifically, is he referring to? Whether or not it is good public policy to reduce the deductibility of charitable contributions, it is one category of tax expenditure that doesn’t seem to fit the loophole category. The charitable deduction has existed in federal law since 1917 and applies to nearly all taxpayers (since even non-itemizers have the value of charitable contributions factored into the standard deduction).
Nonprofit advocates can even juxtapose the personal benefit of other deductions, such as the mortgage interest deduction, against the charitable deduction. For the mortgage interest deduction, the economic benefit of the deduction accrues to the taxpayer. With the charitable deduction, the taxpayer gets no personal economic benefit—in theory—from donating to a public charity. So far, while there are members of Congress willing to discuss the deduction, mostly within the context of comprehensive tax reform, no one has stepped forward to champion the president’s proposal.
In part, the nonprofit sector lobbying effort of the past few years gets the credit. The nonprofit sector has elevated the charitable deduction from a side issue to a core element of the nation’s public policy debate concerning federal government revenues and expenditures. During the four years of President Obama’s first term, the charitable deduction vaulted high in the perceptions of the public and the press. A Nexis count of press stories with the phrase “charitable deduction” for every month of the president’s first term, with duplicates of moderate similarity eliminated, shows a crescendo of attention to the question of charitable deductions as a matter of public policy:
Some of the months match up with the timing of various budget debates and standoffs, but the surge in charitable deduction coverage in the last quarter of 2012 appears tied to news coverage of tax issues potentially involved in the fiscal cliff negotiations. Likely because of the lobbying efforts of charities in early December, there were more than four times as many charitable deduction mentions in December of 2012 as there was the previous December.
What Triggered House Charitable Deduction Hearing and What Came from It?
In early December, charities across the nation carried out an intensive Capitol Hill lobbying effort that was reflected in the significant increase in news coverage of the charitable deduction. That continued into February as the House Ways and Means Committee, under chair Dave Camp (R-Mich.), convened a special hearing on the future of the charitable deduction. What prompted this all-day hearing featuring representatives of more than 40 major charities as witnesses? What prompted the head of the United Way Worldwide to testify about the need to protect the charitable deduction even though the president’s proposal had gone nowhere even when the president and Congress had the best possible opportunity to enact it (i.e., during the fiscal cliff legislation battle, which was largely focused on tax revenues as opposed to spending cuts)?
According to the Committee transcript, United Way Worldwide President and CEO Brian Gallagher testified, “Consider just what the cap at 28 percent would do to just giving to United Way. Our most conservative estimate is that it would reduce giving to United Way across the country by $100 million. That’s like wiping out the United Ways in Philadelphia and in Cleveland or take the 10 mid-size and small United Ways who are going to testify here today – that wipes out all of them, that $100 million.” Many people in the crowded hearing room interpreted these statements to mean that the cap would actually wipe out various United Ways.
Consider this reaction from Rep. Adrian Smith (R-Neb.) in response to Gallagher: “Mr. Gallagher, you – you illustrated in your testimony that perhaps a change has suggested by various entities or parties that it would perhaps lead to the elimination of United Ways in Philadelphia, Washington D.C., and Cleveland or I think you — you, involved in the print that says ‘or all of the work of 10 or 20 United Ways, if changes would occur.’ Now, for the record that would be an option for you to take, not necessarily a mandate for you to take that approach, should changes occur?” The minor panic that the president’s 28 percent proposal would actually shut down large United Ways was palpable, albeit clearly wrong.
Charities received a warm welcome by the Ways and Means Committee. Rep. Sander Levin (D-Mich.) pronounced the charitable deduction “not a loophole” and no one on the panel suggested cutting back on the deduction. Rep. Richard Neal (D-Mass.) gave an extensive statement about the “spectacular” charities in his Berkshires district as well as local hospitals to “point out the incredible diversity of the nonprofit sector which is one of this country’s great assets and why I’m so hesitant to start pursuing out what’s a basic need and what’s not.” This was an affirmation of the unified picture of the nonprofit sector that the testifiers were eager to present.
Just about every member of the Ways and Means panel followed suit with competing panegyrics to the nonprofit sector and the charitable deduction. So why convene the hearing, especially after the passage of fiscal cliff legislation (the American Taxpayer Relief Act of 2012) which, according to the Urban Institute, will actually increase charitable giving by an estimated 1.3 percent? Rep. Jim McDermott (D-Wash.) called out his colleagues on the panel: “I was trying to figure out what these hearings are about and I don’t know whether the purpose was to panic the charitable community into rushing to Washington to talk about what their deductions were all about. If that’s the point, I guess we’ve done it.” After a response of sorts from chairman Camp, McDermott continued, “Is it we’re sort of softening them up for the fact that they’re going to get clipped or are we saying today, ‘Gee, we heard from you and we understand that this is a bad idea?’ No, I can’t…judge yet quite what this hearing is about, but I appreciate [that] you’re all [here].”
McDermott basically charged that the Republicans on the panel were trying to whip up nonprofit sector fears that the charitable deduction would inevitably be “clipped” if Congress pursued comprehensive tax reform, telling ranking member John Lewis (D-Ga.), “These folks are going to be 100 percent against doing what is perceived as what might happen in tax reform in this country.” Did the nonprofit sector fall prey to a scheme to rope them in as opponents to tax reform by panicking them about the future fate of the charitable deduction?
No one outside of inner GOP circles can judge what was really behind the Republican majority’s rationale for a hearing focused solely on the charitable deduction. Some might have been sincerely committed to an exploration of the charitable deduction controversy, but it did nonetheless seem to be something of a congressional show trial of President Obama’s idea for modifying the charitable deduction and other itemized deductions. Proponents of the president’s proposal were next to invisible, while Mitt Romney’s off-handed presidential campaign trail suggestion about limiting the total amount of itemized deductions at $25,000 or $50,000 was mercilessly savaged.
Did the hearing accomplish something important? Yes, but perhaps in a less than positive way for some nonprofits. Rep. Charles Boustany (R-La.) asked one witness whether Congress should give more preferable tax treatment to donors who give to U.S. organizations as opposed to donors that give to nonprofits that help people in other countries. McDermott responded incredulously to this jingoistic, “America first” take on the charitable deduction: “When you start saying we’re only going to give to America, that’s like buying America. A lot of us give a lot of money to organizations that are based outside this country that are doing things in global health all over the world. And for anybody to start putting those kinds of prescriptions to law really don’t make sense to me.”
Rep. Charles Rangel (D-N.Y.) shifted the hearing’s focus to foundations: “How much…actually goes to assist people that have problems that concerned poverty or their well being, they must be worried in the foundation charitable business” about being asked to “demonstrate…those things that are directly related to issues such as education and healthcare, and poverty.” The Urban Institute’s Eugene Steuerle responded that “only a small minority of contributions” go to nonprofits that “directly serve the poor.” Steuerle didn’t make a point of noting whether his response described foundation grantmaking or all charitable giving more broadly, though it is accurate in both circumstances.
Concerned about poverty, Rangel continued, “What type of incentives could we do for this as opposed to other worthwhile foundation and charitable work? Is there anything that you could do so that, if I decide to get my deductions from a tax provision, that I can target it to the 10 percent rather than the 90 percent?” Supported by similar questions from Rep. Xavier Becerra (D-Calif.), the discussion turned to the question of whether there should be a mechanism for targeting charitable deductions to aid the poor—or a program incentivizing charitable giving to nonprofits and programs that address basic human needs.
This opens a line of questioning that may be uncomfortable for some nonprofit advocates. As Rangel noted, “Talking about the poor is never very comfortable.” As the table below indicates, charitable giving for basic needs ranks low among the priorities of the top income group:
Taxpayers with income of $0 to $100,000
Taxpayers with incomes of $100,000 to $200,000
Taxpayers with incomes of $200,000 to $1 million
Taxpayers with incomes of $1 million or more
Combined purpose charities
Helping to meet basic needs
Adapted from slides titled, “Effects of Limiting Charitable Deductions on Nonprofit Finances,” prepared by Joseph Cordes, George Washington University; presented at the Urban Institute program, “The Charitable Deduction: A View from the Other Side of the Cliff” (February 28, 2013).
Given that the poor are already losing out on government grants due to budget cuts and now the sequester, advocates of enhanced charitable giving may well find themselves facing more tough questioning from the likes of Rangel and Becerra. How much of the projected $39 billion in projected 2013 charitable deductions will directly benefit the poor?
Shifting the Focus from the Charitable Deduction to the Impact of Budget Cuts
The U.S. House Ways and Means Committee hearing occurred only two weeks before the deadline of $85 billion in sequestration cuts which we now know that Congress and the White House were unable to negotiate away. Did any of the 42 nonprofit witnesses at the hearing seize the opportunity to speak about federal budget cuts as an issue of nonprofit concern comparable to the panic (to use McDermott’s term) about the charitable deduction?
Karen Rathke of the Heartland United Way explained the link of the deduction to the impending sequester: “If you look at cutting programs for the most basic needs for the people in our communities at the same time that you talk about removing incentives for people to give to charities, who are also trying to balance an increased demand on programs and services with a reduction in funding for those programs, you are kind of caught between both doors.” Vincent Faris of Meals on Wheels told the Committee that his affiliates “are currently facing a quadruple whammy to a growing senior population facing the threat of hunger, state and local budget cuts coupled with the threat of sequestration, higher cost for food and transportation and of course challenging fundraising due to a sluggish economy.”
Other than a few references like the above, however, federal budget cuts didn’t rise to the level of being a big theme in a hearing on the charitable deduction. Nonetheless, the impact of ten years of sequestration cuts—or one year of cuts—is significant for poverty-focused nonprofits. We have noted what such cuts may mean to AmeriCorps, health clinics, affordable housing, and community development. In light of the limited proportion of charitable giving that goes to programs and nonprofits addressing basic human needs, serial budget cuts have weakened the infrastructure of the nation’s social safety net. Perhaps that’s why Oxfam America senior research advisor Andrew L. Yarrow declared the sequester a “supremely foolish and cowardly exercise in policy making.”
Will charitable giving make up for the sequester-caused loss of WIC nutrition aid to 600,000 mothers and children, the 70,000 children who will lose Head Start slots, the 125,000 families to lose rental housing vouchers, the 370,000 adults and children to lose mental health treatment, and the four million less Meals on Wheels to be served to the elderly? Those examples of Yarrow’s are all domestic. A staff writer for Devex, John Alliage Morales, identified sequestration impacts of $1.7 billion in humanitarian foreign aid, including cuts of $49 million in international disaster assistance, $127 million in USAID’s Development Assistance Program, $74 million from Food for Peace, $45 million from the Millennium Challenge Corporation, and $19 million out of the Peace Corps budget.
Has the nonprofit sector focused too narrowly on a threat to the charitable deduction that may not be all that real? Has the sector allowed itself to become seen on Capitol Hill as so parochial that big issues beyond the charitable deduction don’t register? Consider the proposal of Rep. Ed Markey (D-Mass.), one of the more liberal members of Congress and a close ally of President Obama. Calling for over $1 trillion in new revenues over 10 years, Markey proposes closing corporate tax loopholes and various kinds of overseas tax evasion ($700 billion), closing the carried interest loophole ($23.5 billion), closing the loophole for jets and yachts ($4 billion), closing the loophole for corporate deductions of stock options ($25 billion), reducing the corporate meal and entertainment deduction ($70 billion), and increasing the taxes that oil companies pay toward the Oil Spill Liability Trust Fund ($189 billion). We don’t see the charitable deduction in the Markey plan. It doesn’t matter whether the president’s 28 percent limit is good policy. It doesn’t have much traction in Congress even among the president’s most solid congressional allies.
Maybe the nonprofit sector is being played a bit. Are opponents of the kind of tax proposals that Markey outlines using the nonprofit sector as a prop? Are nonprofit voices being diverted from focusing on the cascading federal budget cuts that have slowly chipped away at this nation’s social safety net? In the last couple of days, responding to the need to refocus the nonprofit sector on federal domestic spending issues, the National Council of Nonprofits announced a new plan for “documenting the human effects of sequestration cuts.” In a statement issued in the wake of President Obama’s signing of the fiscal cliff legislation, the National Council’s Tim Delaney explained, “As the reality of sequestration cuts play out, the work of nonprofits is going to become even more difficult from multiple compounding factors as many are hit by direct funding cuts to programs, hit again as state and local governments cut their funding further to make up for their own budgets being cut, and hit a third time as people who are furloughed or laid off as part of sequestration turn to nonprofits for help in unprecedented numbers.”
Can the nonprofit sector recover its focus and reduce its obsession with the charitable deduction, which doesn’t look all that threatened? Can the sector now focus on the more fundamental threats posed to nonprofits and the communities that they serve from federal budget cuts past, present, and future?