charitable giving and the personal income tax

8/8/2019 Charitable Giving and the Personal Income Tax

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Summary PresidentObamahasproposedloweringtherateatwhichhigh-incometaxpayer

canclaimdeductionsromtheirincometaxorcharitabledonations.Fromaneconomic

perspective,thispaperreviewsthreechallengestopolicymakersortreatingcharitable

donationsequitably:(1)howmuchtoincentivizecharitablegiving, (2)whetherequity

amongtaxpayersoughttobedenedbeoreoratertheirdonations,and(3)i,andhow

much,thetaxrateshouldgrowwithincomelevel.

Considering the Proposal Inhisbudgetorscalyear2011,PresidentObamaproposedareductionintherateawhichhigh-incomeearnerscouldclaimanincometaxdeductionorcharitabledonations.

Ordinarily,itaxpayersareallowedtodeduct$1,orexample,romtheirtaxableincome

oracharitabledonation,thenthetaxtheyoweallsbywhateveristheirmarginal tax rate

thatis,thetaxratethatappliestothelastdollarotheirtaxableincome.Sincemargina

taxratesincreasewithtaxableincome,higher-incomeindividualstendtogetmoretax

reductionperdollarocharity(oranyotheritemizeddeduction).IntheObamaproposal,

high-incometaxpayersinthe36or39.6marginaltaxratebracketswouldhavethetaxvalue

otheirdeductionslimitedto28percent,themarginaltaxrateaectingmoremiddle-

incomeearners.IntheTreasuryDepartmentsexplanationotheproposal,

Increasingtheincometaxliabilityohigher-incometaxpayerswouldreducethedecit,make

theincometaxsystemmoreprogressive,anddistributethecostogovernmentmoreairly

amongtaxpayersovariousincomelevels.1

Regardingtheissueoairness,thenDirectorotheOceoManagementandBudget

PeterOrszag,explained:

[L]etslookathowthetaxcodetreatstwodierentcontributorstoanon-prot.Iyourea

teachermaking$50,000ayearanddecidetodonate$1,000totheRedCrossorUnitedWay,

youenjoyataxbreako$150.IyouareWarrenBuetorBillGatesandyouamakethat

samedonation,yougeta$350deductionmorethantwicethebreakastheteacher.

ThisproposalwalksthatdierencebacksomeothewayitwouldlimitthetaxbenetorBuetorGatesto$280.Inotherwords,wearenoteliminatingthedeductionjust

reducingitto28percent(or$280onthehypothetical$1,000contribution)orthe5percent

oamiliesattheverytopotheincomedistribution.2

HarvardUniversity economistMartinFeldsteinwrites:theproposed tax on

charitablegitshitsattheoundationoourpluralisticsociety,3reerringtotheexpected

reductionincharitablegivingthatwouldoccurshouldtheproposalbecomelaw.

MICHAEL RUSHTON

Assosciate Professor and

Director of MPA and

Arts Administration Programs

School of Public and Environmental Affairs

[email protected]

SPEAInsightsSchool of Public and Environmental Affairs (SPEA) Indiana University September 2010

Peer Reviewers and Contributors:Leslie Lenkowsky, Clinical Proessor,

School o Public and Environmental Aairs,Indiana University; and Kirsten Grnbjerg,

Proessor and Governance & ManagementFaculty Chair, School o Public and

Environmental Aairs, and EroymsonChair in Philanthropy, Center onPhilanthropy, Indiana University

Charitable Giving and the Personal Income Tax

The views expressed are solely those o the

author and do not imply endorsement byIndiana University or the School o Public andEnvironmental Aairs.

1DepartmentoTreasury,GeneralExplanationotheAdministrationsFiscalYear2011RevenuProposals,February2010.

2Peter Orszag, The Budget and Charitable Donations [http://www.whitehouse.gov/omblog/09/02/27/TheBudgetandCharitableDonations/;postedFebruary27,2009.]


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Thisarticlewillshowthecomplexityunderlyingwhatseems

onthesurace tobe arelatively straightorward changeto the

treatmentocharitablegivingintheincometax,andthat,while

economistshavesomethingtocontributetothedebate,theydont

havealltheanswers.

Toevaluatethetreatmentocharitabledonationsintheincome

tax,it sbesttobeginwiththemultiplegoalsoawell-designed

personalincometax.

Efciency, which involves ensuring that the tax system isgeneratingincentivesordesirablebehavior,

Horizontal equity, which is about treating those in similar

circumstances in a similar way, rather than with arbitrary

distinctionsbetweentaxpayers,

Vertical equity, themoral view that the total amount o tax

assessedonanindividualshouldberelatedtohisabilitytopay,

Easeotaxadministrationandenorcement(bythegovernment)

andcompliance(bythetaxpayer).

Issues for Policymakers

Thechallengesinguringouthowbesttotreatcharitabledonationsare:

1.Wearenotsurebyhowmuchwewanttoincentivizecharitable

giving

2.There has long been disagreement about whether similar

circumstances or the purposes o horizontal equity should

bemeasuredpriortooratercharitabledonationshavetaken

place

3.Therearewidelydivergentviewsontheextenttowhichthetax

rateoughttoincrease,iatall,withabilitytopay.

1. How much incentive for charitable giving?

Econometric studies on the question suggest that the

elasticityocharitabledonationswithrespecttochangesinthe

marginalrateatwhichdonationscanbedeductedromtaxable

incomeisaroundunity.Inpracticethismeansthattheincrease

ingovernmentrevenuesromreducingtheeectivetaxdeduction

isalmostexactlyosetbythechangeinthedonationscharities

receive. Martin Feldstein calls the Obama proposal a tax on

charitable gits because, as an approximation, the increase in

governmentrevenueismatchedbyadeclineingitsreceivedby

charity.Notingthatthetaxchangeappliesonlytohigh-income

households who itemize their deductions, Indiana Universitys

CenteronPhilanthropyestimatedthat,iimplemented,thetax

proposalwouldreducecharitabledonationsbyabout$3.9billion

otheestimated$187billionitemizedannuallyincharitablegits

(which,ocourse,islessthanthetotalamountogiving).4

Suppose that estimatesoadeclineindonationsmatching

an increase in government revenues are roughly correct. That

inormationalonedoesntconrmwhetherthisisagoodorabad

policymovebythegovernmentbecausewecannotsimplyassume

thattheexistingincentivesordonationswererightintherst

place.Ineciencytermsi.e.,intermsogettingtheincentive

rightor charitable giving there was neveranythingmagica

abouttheprevioussystemwheretheincentivewassetata leve

equaltotheindividualtaxpayersmarginaltaxrate.Aterall,there

aresystemsthatgivegreaterincentivesorgivingthanwhatha

existedintheUS.InCanada,orexample,taxpayersreceiveatax

creditorcharitabledonationsatarateequaltothetopmarginal

incometaxrate.TousePeterOrszagsexampleagain,insteado

loweringthetaxbenetorhigh-incomeindividualstothelevel

receivedbyothers,inCanadathetaxbenetormiddle-income

amiliesisraisedtothelevelreceivedbytherichestdonorsand

thisinacountrywherethemarginaltaxrate(andthusthevalue

atthemarginothetaxbenet)isalreadyhigherthanintheUS

Intermsotheincentivesprovidedorcharitablegiving,there

isnothingspecialabouttheextantsystemintheUS.Itcouldbe

madestrongerorweaker,dependingonthedegreetowhichpolicy

makersarepreparedtosacricegovernmentrevenue(whichmus

bemadeupinhighertaxeselsewhere,orincutstoexpendituresinorderornonprotstohavemorerevenue.

2. What is horizontally equitable when it comes to the tax treatment

of charitable giving?

Considerrsttheactthattaxpayerswhoaresel-employed

candeductexpensesincurredinearningalivingromtheirtaxable

income.Aslongastheexpensesaretrulynecessaryandaparto

thebusiness,ewwouldobjecttothisprovisionin thetaxcode

sincemostbelieveitisairandequitabletotaxnetearningsrather

thangrossreceipts,netearningsbeingaarbetterindicatoroa

personseconomiccircumstancesandwellbeing.

Ontheotherhand,mosttaxpayerswouldobjectitherewereataxdeductionbasedonconsumptionobananas(butnoothe

oods).Itwouldseemcrazythattwopeopleoequalincomeand

circumstancewouldbetaxeddierentlybecauseonelikedto

purchasebananasandsoreceivedageneroustaxdeduction,while

theotherstronglypreerredtobuyotherruitandreceivedno

deduction.

Intermsoequity,i.e.,treatingpeopleinsimilarcircumstance

withoutarbitrarydistinctionsbetweenthem,arecharitable

deductionsmoreakintobusinessexpensesor consumptiono

bananas?Icharitabledonationsareakintobusinessexpensesin

termsodeningapersonscircumstances,thenthewaydonations

havebeentreatedinthepastmakessomesense. Thequestion abovemayseemsilly,butithasbeena par

othediscussionothedesignothepersonalincometaxrom

thebeginning.Althoughtaxpayershavebecomeaccustomedt

thisitemizedtaxdeduction,ithaslongmademanyeconomist

uneasy.Inetpersonalincomeisthebestmeasureoindividuals

circumstancesbecauseitdenestheirpowerovertheallocationo

resourceswhethertheychoosetospendit,saveit,orgiveitaway

thenthetaxdeductionorcharitabledonationsisnolongerso

easytodeend.Sinceoneindividualcanchoosetogivemoneytothe

IndianapolisMuseumoArt,orexample,andanotherindividua

withsimilarincomecanchoosenotto,itsunclearwhythers

3MartinFeldstein,ADeductionromCharity,Washington Post,March25,2009.

4ObamasTaxPlanCouldCauseGivingbytheWealthytoDropbySeveralBillionDollarsAnnuallyChronicle o Philanthropy,February27,2009.


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oughttogetataxdeductionsimplybecausehe chosetousesome

ohisdiscretionaryincomeinthatparticularway.

3. How progressive should the income tax be?

TheObama administrationproposal aims tolimittherate

atwhichonlyhigh-incomeearnerscouldclaimthecharitable

deduction.Andsoanotherquestioniswhetheritisgoodpolicyto

increasetheincometaxpaidbyrichcharitabledonorswhileleaving

thetaxratesorothersunchanged.(This,ocourse,ignoresthe

manyotherchangestotheoveralltaxandgovernmentexpenditure

systemthataectallindividualsindierentways).

Again,thereisnoeasyanswer.Wheneconomistshavetriedto

estimatehowprogressivetheincometaxoughtoptimallytobe,they

combinewhattheyknowabouttaxesandincentivesonworkand

savingtogetherwithsomewhatarbitrarysocialwelareunctions

thatpositivelyaccountorboththetotalincomeosocietyand

howevenlyater-taxincomeisdistributed.However,thereisno

scienticwaytondthatsocialwelareormula,andthereareno

calculationsthatwouldindicatehowtovalueequality.

Thatdoesntmeantheseexercisesareworthless.Thewaveo

taxreormaroundtheglobeinthe1980swhichinvolvedsharpcutsintheveryhighmarginaltaxratesorthehighestincomeearners

werearesult,inpart,ostudiesthatshowedthatevenincountries

thatcaredalotaboutater-taxincomeequality,thoseveryhightop

marginalrateswereproducingbiglossesintotalincomewithvery

littlegaininequality.HumesLawprobablyapplieshere:ought

statementscannotbederivedromisstatements,anddiscussions

abouthowmuchtherichoughttobetaxedcannotbebasedpurely

oneconometricstudiesoincentiveeects.

Implications for the Obama Proposal onCharitable Giving

Economistscertainlycancontributetothispolicyquestion.First,theycanidentiytheincentiveeectsochangingpolicies,and

provideestimatesotheirmagnitudes.Therecannotbeasensible

discussionoapolicyissuethatinvolvestrade-oswithouthaving

someideaothenumbersinvolved,andsoundempiricalevidence

cantaketheensuingdiscussionpastanecdotesabouthowonedonor

oranotherrespondstochangesinthetaxlaw.

Second,thereisnoidealsystem.Rather,whatoughttobedone

isdeterminedintherealworldbyacomplexinteractionbetween

howpeoplerespondtoincentives,andwhatisbelievedtopresent

airnessintaxation.

Theoptimaldesignotheincometax,includinghowittreats

charitablegiving,isapoliticalquestionpoliticalinthebestsense.Itissomethingthathastobeworkedoutbetweencitizens

andtheirelectedrepresentativesbasedonacompromiseovalues

betweenwhatconstitutesairnessintaxation,andthedegree

towhich theybelieve itis soundpolicy or the government to

activelyencouragecharitablegiving.Policyanalysiscancontribute

estimatesoimportantmagnitudes,andprovidearameworkor

organizingthoughtsonthesubject,butbeyondthat,deliberations

anddemocracymustprevail.

*****

CommentsonCharitableGivingandthePersonalIncomeTax

by Kirsten Grnbjerg

ProessorRushtonassessmentotheimpac

ochangesinthetaxlawoncharitablegiving

rightlyemphasizesthecomplexityothis

importantpolicyissue.Ashenotes,thereare

notonlymajorquestionsabouttheeconomic

impactotaxchanges,butthesocialandpoliticaldimensionsto

theseissuesareatleastasproblematic.

Myreadingotheliteratureleadsmetoslightlymorenuanced

conclusionsabouttheimpactochangesintaxincentivesor

charitable contributionsthanhis.Thereis,or example,some

evidencethatclear-cutchangesintaxincentiveshaveatemporary

eectoncharitablegiving,especiallyorveryhigh-incomegroups.

Thatis,itaxratesarescheduledtodeclineJanuary1,individualmaymovetheirgitsorwardintimetotakeadvantageothemor

avorabletaxincentiveswhiletheyareinorce.Itheseindividuals

thenmakesmaller/ewergitsimmediatelyollowingthedecrease

intaxrates,itappearsthatcharitablecontributionsarelowerate

thechangeintaxratesthanbeore.

Whilethereisalsosomeevidencethatchangesintaxrate

havealong-termorpermanenteectonthepropensitytogive

ewstudiestestor timingvs.permanenteects.Moreover,tax

incentivesarenottheprimaryreasonswhydonorsgive. 2Indeed

therearemanynon-economicactorstotakeintoaccount.For

example,mengivelargersumstoewercharitiesthanwomenand

tendtobemoregenerouswhenitischeaptogive(e.g.,hightaxincentives),whilewomentendtobemoregenerouswhenthecost

ogivingishigh(e.g.,lowtaxincentives).3

Oneotherobservationurther complicatestheanalysis o

taxincentivesandequityissues.ThathastodowithwhatPau

Schervishandcolleaguesreertoasthehyperagencyowealth

thatis,theabilityowealthydonorstohaveadisproportionat

impactoncharitiesbecausetheycananddogivelargegit

withstringsattached. 4Inotherwords,majordonorstheone

aectedbytheproposedchangesinthedeductibilityocharitable

donationswouldcontinueto receivesignicanttax incentive

ormakingcharitablecontributions,justnothigherincentives

1See Jon Bakija and Bradley T. Heim. (Forthcoming). How DoeCharitableGivingRespondtoIncentivesandIncome?NewEstimateromPanelData.National Tax Journal.

2SeeLiseVesterlund.(2006).WhyDoPeopleGive?Pp.568-590iWalterW.PowellandRichardSteinberg(Eds.),The Nonproft Sector: AResearch Handbook.NewHavenandLondon:YaleUniversityPress.

3SeeBaris K.Yrk.(2010).CharitableGiving byMarriedCoupleRevisited, Journal o Human Resources (45):497-516.

4SeePaulG.Schervish,PlantonE.Coutsoukis,andEthanLewis.(1994).Gospels o Wealth: How the Rich Portray Their Lives.Westport,CTandLondon:PraegerPublisher.


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Each issue of SPEA Insighthighlights a major public policy

challenge in the USA or the world, along with analysis by SPEA

faculty and other experts that will help policy makers address

these challenges.

www.spea.indiana.edu

thanthoseinthesecond-highesttaxbracket.Inact,theirtax

incentiveswouldcontinuetobenotablyhigherthanoramilies

inthelowesttaxbrackets.Moreover,therewouldbenoerosion

othesocialandpoliticalbenetshigh-incomedonorsgetrom

theircharitabledonationstheabilitytoimposetheirwillonthe

agendasocharitiesreceivingtheirgits.Thosetypesobenets

arerarelyavailabletothosewhocanaordonlymodestgits,even

thoughtheaggregatevalueotheirgitsissignicant.5Moreover,

nothingpreventshigh-incomeindividuals(thosewithincomeo

$250,000ormoreunderthecurrent 6proposal)romcontinuingto

makehigh-impactgits,butitisapoliticalquestionwhethertax-

payersshouldcontinuetounderwritesuchgitstoagreaterextent

thanthesmallergitsromthevastmajorityoamilies(roughly

95percentoamilieshadincomesbelow$200,000in2006).

SoIullyagreewithProessorRushtonsoverallconclusion,

thatpolicydecisionsingeneral,andthisoneinparticular,should

bebasedonasolidunderstandingothecomplexitiesocharitable

contributions,butthatwemustgobeyondeconometricanalyses

toconsiderbroaderpoliticalandsocialimplications.

5

Familieswithincomeolessthan$250,000(about$200,000in2002dollars)accountor52percentoallcharitablecontributions.Seetable23.5 in John J. Havens,Mary A. OHerlihy, and PaulG. Schervich.(2006).CharitableGiving:HowMuch,byWhom,toWhat,andHow?Pp. 542-68 inWalterW. Powell andRichard Steinberg (Eds.),TheNonproft Sector: A Research Handbook.NewHavenandLondon:YaleUniversityPress.

by Les Lenkowsky

UsingasPresidentObamasunsuccessul

eorttoreducethedeductibilityocharitable

givingbythewealthyasanexample,Michael

Rushtonmakesvaluableobservationsabout

thelimitsoeconomicandpublicpolicy

analysis indecision-making.Tax policy,he

notes,isultimatelytheproductodemocraticdebate,not social

scienceresearchandanalysis.Atitsbest,economic(andpublic

policy)analysiscanuseullyinormchoicesbyilluminatingthe

contextinwhichtheyaremadeortheresultstheyproduce.But

politicaldebateanddiscussionarenecessarytoevaluatethemerits

odecisionsordeterminewhichgoalsareworthseeking. Evenso,socialscienceisnotpoliticallyneutral.Deliberatelyor

not,bythenatureothequestionsasked,thedatacollected,orthe

interpretationsplacedontheresults,analystscananddoespouse

politicalpositions,sometimesunderthecloakoconducting

objective research.Thedebate over theimpact otaxationon

charitablegivingprovidesagoodexampleothat,too.

Thestandardeconomicmodelohowpublicpolicyaects

givingrelieschiefyontwoactors.OneisaddressedinRushtons

paper:theeectotaxdeductionsorcreditsinincreasing(or

decreasing)theincentivetodonate.Byreducingthevalueothe

charitablegitdeductionorhigh-incometaxpayers,theObama

administrationsproposalwould,accordingtoitscritics,leadtoles

charitablegiving.Ontheotherhand,itsdeendersclaimanysuch

eectwouldbesmallandjustiableinnon-economicterms,such

asbyproducinggreaterequityinthetaxsystem.

Forover40years,thebulkotheresearchintotheeecto

publicpolicyongivinghasocusedontaxincentivesandso,not

surprisingly,havepoliticaldebates.Butthesecondactorinthe

modelisalsoimportant:theamountodisposableincomeaperson

has.AsstudiessuchasGiving USAhaveshown,aggregatechange

inthelevelocharitablegivingcloselyollowchangesinnationa

income(andwealth,asmeasured,orexample,by stockmarke

indices).Amongindividuals,whileraisingorloweringdeduction

hasmoreimmediatesignicance,gainsorlossesinincomearenot

inconsequentialanditheycontinueoranumberoyears,have

acumulativeimpact.

Thesetwoactorscanbeseenindebatesovertheimpacto

abolishingtheestatetaxoncharitablegiving.Thosewhoavo

reinstatingitarguethattheestatetaxcontainedastrongincentive

orphilanthropybypermittingadeductionorbequests.Ontheotherhand,thosewhosupportitsabolitionmaintainthatpeople

willbemorelikelytoaccumulatewealthitheythoughtitwould

notbetaxedawayatdeathand,thus,moregeneroustocharityin

theirlietimesaswell.

Most estate-tax research, likemost studiesotax policy

impactgenerallyoncharitablegiving,hasocusedonthebeques

deductionsincentive-eects,ratherthanonhowinheritance

taxationhasaectedincreasesinwealthorthetimingocharitable

giving.(Supply-sideadvocateswouldsaythatthedynamiceect

otaxationonpersonalandcapitalincomeareunder-studiedas

well.)Yet,almostsurely,despitethepreerencesoresearcherso

studyinganddebatingtheObamaadministrationsproposedchangeinthetaxincentiveordonationsbythewealthy,thesuccessoits

economicpoliciesinstimulatinggrowthinincomeandwealthwill

haveaarmoreprooundeectoncharitablegiving.

charitable giving and the personal income tax

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