Would Obama’s Plan to Curb Deductions Hurt Charities?

By :: March 3rd, 2009

Critics charge that President Obama’s plan to limit the value of itemized deductions to 28 percent would hurt charities at the time they most need financial support. Their argument: Since the maximum value of the deduction for donations to charity would fall from 39.6 percent to just 28 percent , the affluent will give less.  Republican Whip, Eric Cantor, asked, “Is there any better time to have charities in full throttle than when you have tough economic times?” 

How much would the proposal affect donations? A back-of-the envelope estimate suggests that the Obama plan would reduce annual giving by about two percent, or roughly $9 billion. Here’s how we got there.

The proposal would cut deductions for taxpayers in the top two tax brackets starting in 2011, when the top rates will be 36 and 39.6.  About 1.2 percent of households would be affected in 2011. 

Of course, higher income households donate more to charity than those with lower incomes, so the proposal affects a larger share of charitable contributions.  We estimate that 18.2 percent of charitable contributions itemized on tax returns are in the top two brackets in 2011.  Itemizers account for two-thirds of total charitable contributions in 2006, the latest year for which data are available.  Non-itemizers, bequests, foundations, and corporations—none of which would be affected by the proposal—account for the other giving.

Thus, limiting itemized deductions would affect roughly 12 percent of contributions.  Assuming that a one percent increase in the “tax price” of contributions induces a one percent cut in donations, this would translate into a $9 billion reduction in annual giving.  (See, e.g., this recent paper by Jon Bakija and Brad Heim for recent estimates of the elasticity of charitable contributions with respect to the tax price.)

That is not insignificant, although it is somewhat ironic that conservatives have only now discovered the virtues of high tax rates in boosting charitable contributions.  Researchers have found that the estate tax has much larger effects on philanthropy.  A 2004 CBO study estimated that repeal would have cut contributions by between $13 billion and $25 billion in 2000, but conservatives scoffed at the possibility of such behavioral effects.  Obama’s budget would retain the estate tax, which on net would likely boost contributions by more (compared with repeal) than limiting the deduction would cut them.

If we really want to unleash a flood of philanthropy, maybe the Administration should increase top rates even more and eliminate the deduction limit.  Assuming that contributions are sensitive to the tax price, this would unleash a flood of philanthropy and produce revenue for the Treasury at the same time.

Postscript:  Several readers have asked why our estimate of the effect on charities is different from the 1.3 percent change estimated by the Center on Budget and Policy Priorities.  The Center estimated the effect on current giving by comparing the effect of a top rate of 35 percent to an effective rate on contributions of 28 percent under the proposal.  They are effectively comparing 2011 to 2010.  I also estimate that change to be 1.3 percent under the assumptions described above.  The 2 percent estimate compares giving in 2011 under the proposal to giving in 2011 under current law, when the top tax rate is scheduled to return to 39.6 percent.