How to Cut the Charitable Deduction Without Reducing Giving

By :: December 5th, 2012

If income tax deductions are capped or limited—an idea that often comes up in the debate over both the fiscal cliff and long-run tax reform—the biggest losers could well be charities. At a time when the government role in providing a safety net may shrink, many of these groups may become increasingly important.  Yet deduction limits could discourage contributions to charities, in some cases substantially.

The challenge: Raise revenue without discouraging giving.

That’s not easy. Take, for example, the kind of dollar cap on deductions proposed by Mitt Romney and others.

Most deductible expenses that would be subject to a cap or limit are non-discretionary.  For instance, we must pay state and local taxes and many of us must continue to pay mortgage interest.  But charitable giving is entirely discretionary. Thus, a taxpayer trying to squeeze all of her deductions into a fixed dollar cap is more likely to reduce her charitable giving-- though by how much is a matter of debate.

And that’s where the story gets interesting. And where it suggests there may be ways to increase federal revenues without slashing those gifts.

First, let take a quick tour of charitable giving and the deduction. In 2010, individuals and private foundations gave about $250 billion to charities. Contributions, dues, and the like accounted for about 15 percent of their total revenues (the rest comes from program revenues, grants, and investment income).  For lots more detail on charities and taxes, take a look at a nice paper by Roger Colinvaux, Brian Galle, and Gene Steuerle.

The deduction will reduce tax revenues by $40 billion in 2012. And it mostly benefits high earners. Because only about 30 percent of taxpayers itemize, the vast majority of people give without getting any tax benefit, and thus would be indifferent to any form of deduction cap. For instance, TPC estimates that 80 percent of those making $40,000-$50,000 get no deduction for charitable giving (though many do give).

The congressional Joint Committee on Taxation figures that of about $180 billion in deductible contributions in 2011, the 3 percent of taxpayers making $200,000 or more gave nearly 45 percent.  TPC estimates that this group gets 55 percent of the total tax benefit.

Does the tax subsidy increase giving? The research is mixed. The latest studies find the effects are small, especially over the long run. But to the degree it does, it is more likely to affect high-earners-- who may check with their accountant before making a big gift.

There are alternatives to a Romney-type cap. President Obama would limit the value of deductions to 28 percent, thus reducing their benefit for high-bracket taxpayers but not for others. Because high-income taxpayers may be most sensitive to the deduction, such a limit is likely to reduce giving--though not as much as a dollar cap.

But there are other ways to go. For instance, Congress could allow deductions only for giving that exceeds, say, 2 percent of income.  Or, it could replace the deduction with a refundable credit.

Here’s a third option: Allow an above-the-line deduction that would be available to non-itemizers but limit the deduction only to contributions above a floor. The Tax Policy Center figures such a plan (for charitable gifts that exceed 1.7 percent of Adjusted Gross Income) could increase tax revenues by about $10 billion a year, without reducing charitable contributions at all.

The influential charity lobby is already pushing hard to exclude gifts to non-profits from any deduction cap or limit. But doing so would reduce the revenue generated by a dollar cap by one-third. And it could well wreck any effort to limit all deductions. After all, if charities are protected, will the housing lobby be far behind?

Thus, the solution may be to find a way to better target the charitable deduction. TPC and others have shown that’s possible in a carefully designed tax reform. It’s an object lesson, however, in the dangers of a quick-and-dirty deduction cap aimed only to meet a revenue target.

16Comments

  1. Michael Bindner  ::  6:16 pm on December 5th, 2012:

    My tax plan has only two exclusions, sales to a qualified ESOP and charitable deductions over 2 percent of income. My plan includes a consumption tax replacing employer payroll, employee HI/DI/SI payroll and most income taxation under $50,000 for individuals (current income level of about $75,000) or $100,000 for families (current $150,000). Rates may or may not be progressively stepped after that point. Michael Graetz suggests two rates, I suggest five.

    In the end, the decision to keep the deduction is about ideology, not estimation and impact. Do we want to encourage charity and employee ownership among those who are better off or not? If so, then the second question is the trade-off between higher rates and limited deductions.

  2. Brian Dell  ::  6:50 pm on December 5th, 2012:

    I think the housing lobby could be, or should be, resisted even if charities get something of a break because the deductibility of charitable donations is not unique to the U.S. whereas the deductibility of mortgage interest largely is. If the Canadians can hold off the housing lobby why can’t it happen on Washington’s side of the border? The consensus among economists for eliminating the mortgage interest deduction and the deduction for employer provided health insurance is high.

    Instead of looking at is as giving a break to charities first, one could look at it as denying a break to the housing lobby first.

  3. Vivian Darkbloom  ::  4:20 am on December 6th, 2012:

    This post misses a huge point about the tax consequences of the “charitable deduction” and the incentives issue. The ultra-wealthy are currently subsidized in two ways with respect to contributions to “charities”. First, lifetime contributions are deductible for federal income tax purposes and are exempt from gift tax as well. Contributions at death via testamentary bequests are deductible for estate tax purposes.

    Under the Obama budget proposal, the Pease phase-out of itemized deductions would come into force again for “the rich”. This provision ultimately limits deductions (including charitable deductions) to 20 percent of the amount contributed. Second, the 28 percent limit on this 20 percent would effectively mean a 5.6 percent federal income tax benefit to the donor for each dollar contributed. (One wonders why the administration is now hypocritically railing against severely curtailing tax incentives for charitable contributions as they claim the Boehner proposal would do.)

    Gleckman’s post, as well as the paper linked to by Gene Steuerle and others curiously omit the effect of the gift and estate tax rules on charitable giving. Attentive readers will have noticed that that nice paper by the tax-exempt Tax Policy Center was financed courtesy of the Bill and Melinda Gates Foundation and the Charles Stewart Mott Foundation. (Nobody, including those reviewing the tax rules for charitable giving seem to be able to do their fine public service work without themselves getting a tax subsidy for it).

    Under the administration’s proposal, the lifetime exemption for estate and gift tax would be reduced to $3.5 million (from $5.1 million) and the maximum estate tax rate would be hiked up to 45 percent from 35 percent. However, the proposal would not impose any restrictions on charitable giving via bequests. So, it does not take a great tax planner to conclude that by restricting the income tax benefit to 5.6 percent but not restricting similar benefits on the gift and estate tax side (indeed, even increasing the incentives to reduce those taxes) would shift lifetime giving to bequests at death (you can’t take it with you, but you can cling to it until the bitter end). Any restriction on charitable deductions necessarily has to include restrictions for gift and estate tax purposes, too.

    I would suggest that this combination of proposed tax changes is tailor made to Mr. Buffett’s and the Gates’ personal situations. Loyalty indeed has its rewards and is especially gratifying when one is able to retain huge benefits while at the same time appearing to be magnanimous. The vast majority of their wealth will not be given during their lifetimes, but rather by bequests at death.

    By the way, while the Bill and Melinda Gates Foundation (the destination for Buffett’s billions when he dies) undoubtedly does a lot of fine work (other than giving grants to other tax-exempt organizations to opine on how they should not be taxed), the bulk of that Foundation money is actually spent on projects outside the United States. As the New York Times astutely noted in a recent editorial on this general subject, every dollar in tax avoided by the “rich” has to be paid by the “non-rich”. In this respect, isn’t it ironic that by giving so generously to these foreign projects, Mssrs. Gates and Buffett are raising taxes on the “non-rich” in the US, including the poor.

    I look forward to further tax-subsidized papers from the TPC. I suggest an appropriate one to the current debate might be entitled “Reducing Tax Expenditures Makes it Easier to Raise Tax Rates”. Perhaps then people will understand that if we reduce tax expenditures to avoid the fiscal cliff *now* it will be much “easier” to raise tax rates on the rich *later* because their ability to avoid tax at those higher rates via deductions will have been substantially reduced.

  4. Jack B  ::  7:22 am on December 6th, 2012:

    Thanks again Vivian. I always appreciate reading your insightful comments.

  5. JG Cole  ::  9:45 am on December 6th, 2012:

    Maybe its time we redefine 501(C)(3) organizations to only support those that are providing charitable assistance. Take away the deduction for all of those groups preserving historical sites, or supporting arts and humanities projects. Restrict them to organizations providing medical research, assistance to the needy and or infirm (food, medical, housing, etc), etc. I would go so far as to restrict deduction to religious organizations to the fraction of their expenses that are used for these same charitable causes. Why are we giving a tax deduction for contributions to a church building fund, or to pay for minister’s salaries?

  6. Jack B  ::  9:49 am on December 6th, 2012:

    AMEN

  7. Tax Roundup, 12/6/12: Putting the “net” in investment income. And Bar time! Well, Bar Association school time… « Roth & Company, P.C  ::  11:20 am on December 6th, 2012:

    […] Howard Gleckman,  How to Cut the Charitable Deduction Without Reducing Giving (TaxVox) […]

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  9. Steven Woolf  ::  6:09 pm on December 9th, 2012:

    Howard: You make some interesting points. It clear that a dollar cap as proposed by Governor Romney or even the overall limit proposed by the Committee for a Responsible Federal Budget would be extremely detrimental to the charitable sector. In most states with a significant state income tax, this in combination with other tax payments and mortgage interest would either eliminate totally or greatly diminish the value of the charitable contribution deduction. As to studies regarding the impact of changes in taxation to giving, the results may be somewhat mixed but virtually every study shows that there is more sensitivity among higher-income taxpayers. See Jon Bakija’s work and that of John List among others. Middle and higher income taxpayers are those who will be impacted by these proposals and these are the very individuals whose support for a vast array of charities is so essential, at a time when the economy is still recovering, government support fot the safety net is shrinking, and many charities are being asked to pick up the slack.
    CBO estimates also show that imposing floors on deductible giving or transformation to a capped credit with a floor will also result in lower giving.

    In sum, the charitable deduction seems to have worked pretty darn well for almost 100 years. For each $1 in lost revenue through the expenditure, the charitable sector receives almost $3. That money has been leveraged over the years by charities that often prove to be more nimble, more creative, and more responsive than many government programs to help the most vulnerable among us. Do we really need to fix something that may not be broke?

  10. Ending the Charitable Deduction is Part of the Solution | Inequalities  ::  9:52 pm on December 10th, 2012:

    […] so the amount of the deduction is highest for those in the top tax bracket. As it turns out, 55% of the total benefit of the subsidy goes to households in the top 3% (these households account for 45% of all tax […]

  11. Vivian Darkbloom  ::  3:58 pm on December 13th, 2012:

    Well, now, the Washington Post has finally gotten around to *almost* identifying the hypocrisy behind Obama’s stance on the tax breaks for giving to “non-profit” organizations:

    ““When the president proposed reducing the charitable deduction in 2009, initially to help pay for his health-care overhaul initiative, he said there was “very little evidence” that the change would significantly affect giving. Speaking at a press conference, he said the deduction “shouldn’t be a determining factor as to whether you’re given that $100 to the homeless shelter down the street.’’”

    “His proposal helped trigger the lobbying campaign to preserve the current deduction. The effort has involved an array of nonprofits representing artists and musicians to museums, universities and religious groups. Some of the best known nonprofits— including the YMCA of Greater New York, the Boy Scouts of America and the Philanthropy Roundtable — have hired D.C. lobbying firms.
    The charities characterize the lobbying expenses as a sound investment given the money at stake: Americans donated nearly $300 billion to charity last year.”

    WAPO doesn’t quite call Obama out—they should. He’s proposed to restrict the income tax benefit on chartable giving to 5.6 percent for the wealthiest givers. It does not appear that WAPO understands the interaction of the Pease phase-out rules and the 28 percent cap, but at least this is progress.

    The story about the non-profit lobbying efforts is one that begs to be told. There’s a Pulitzer out there for a journalist out with the brains and the guts to do it. Why on earth should we give a tax break on charitable giving in order to allow those “charities” to lobby our legislators? This is the worst form of regulatory capture.

  12. Vivian Darkbloom  ::  3:59 pm on December 13th, 2012:

    Here’s the link to that article:

    http://www.washingtonpost.com/politics/white-house-nonprofit-groups-battle-over-charitable-deductions/2012/12/13/80e67400-43f2-11e2-9648-a2c323a991d6_story_2.html

  13. Vivian Darkbloom  ::  4:10 pm on December 13th, 2012:

    I’m sure similar arguments are routinely made by lobby groups such as “The Coalition for Charitable Giving”. Perhaps that’s no coincidence.

    http://acreform.com/files/pdf/CGC_Advisory_11-27-FINAL.pdf

  14. Budget Revenues: The Growth, The Rates, and The Giving  ::  2:04 am on March 7th, 2014:

    […] in higher tax brackets, sounding alarm bells in the nation’s philanthropic sector. Recall TPC’s Howard Gleckman’s take on how to cap the deduction without reducing giving: be careful, and be […]

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