To balance the budget, Republicans want to raise revenue by getting rid of tax loopholes instead of raising rates. If we are getting rid of loopholes, what about eliminating the income tax deduction on charitable contributions?
Ending the charitable deduction is not a popular idea for either the left or the right to embrace. The wealthy benefit from the deduction the most, but progressive causes, such as soup kitchens and homes for foster youth, depend critically on charitable donations. As Gene Sperling, director of the National Economic Council, put it: “It is hard to design a better way to unite the most-well off Americans and those representing the poorest Americans, non-profits, churches, universities and hospitals, against a single idea than proposing to completely eliminate the charitable deduction.”
Unpopular though it may be, eliminating or limiting the deduction is a sound and fair idea, and would allow the government to collect the $40 billion in taxes that it would otherwise forego every year. Progressives looking for solutions to raising revenue should embrace some version of it.
A nice overview of some of the issues I discuss below is provided by this brief from the Urban Institute/Brookings Tax Policy Center.
The charitable deduction is almost as old as the income tax itself, and it has always been intended as a way to promote and encourage private giving. The scope of organizations covered by the charitable deduction is broad – including service organizations, the arts, universities, animal welfare groups, veterans groups, and of course, private religious organizations. Many of these groups perform functions that the government cannot perform well, and indeed, much of the most innovative work in the United States to address social problems and poverty takes places through private charity. The natural worry is that any steps to eliminate the tax deduction would undermine public goods that are important for health and wellbeing in our society. This is a possibility, but a few points are critical to consider.
First, charitable deductions are only available to households that itemize deductions when they pay their taxes. Only about 30% of taxpaying households do so, however, and these households tend to be in the upper income brackets. Moreover, the charitable deduction applies to a households marginal tax rate (the amount they pay on the last dollar of income), 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 deductible contributions).
Second, the very wealthy are disproportionately less likely to give money to programs that serve basic needs than are lower income households. The chart below provides a nice breakdown of which types of charities different household income groups favor. As the chart reveals, families earning less than $100,000 per year are more likely to give to religious and basic needs groups, and those earning more than $1 million are more likely to give to arts, education, and health. There is nothing inherently wrong with this state of affairs, and causes in all of these categories can provide great social benefit. Still, it’s important to keep in mind that anti-poverty programs will not be as adversely affected by the elimination of the charitable deduction as, say, the New York City Ballet or the Harvard Business School alumni association.
Third, it is not clear how much eliminating the deduction would actually reduce giving. In theory, the tax deduction makes charity “cheaper” since the price that a household pays to give to charity is less than the amount of benefit they can provide to the charity. Existing literature suggests that there is a modest effect of the deduction on giving, but long-term giving patterns are fairly stable and not hugely responsive to tax breaks: “For example, the Tax Reform Act of 1986 reduced the top marginal individual income tax rate from 50 percent to 28 percent. In anticipation of this, individuals may have shifted gifts they would have given in 1987 into 1986 because the after-tax cost of contributing a dollar in 1987 was larger than the after-tax cost in 1986. While this would produce a large effect from the change in after-tax cost of giving in the short-run, the long-run effect would be smaller if the individual returned to a normal pattern of giving thereafter.” Ultimately, the altruism that motivates charitable giving may trump other more self-serving motives to lower tax burden.
When it comes to the nitty gritty of reform, there are other alternatives to completely eliminating the deduction. The TPC brief describes some potential caps, floors, credits, and grants. None of these would bring in as much as completely doing away with the deduction, but they may be more politically palatable. Then again, it is hard to discount the emotional valence that charitable giving has in American civic life. Many families see their charitable giving as a natural extension of their private free expression, and regard the entire system of charitable giving a way of retaining the independent character of religion and keeping the state out of some domains of private life. For some, keeping the charitable deduction does more than provide an incentive to deliver socially useful services, it provides an enduring symbol of the importance of private and community driven solutions. That may be valuable indeed, but I doubt it is worth $40 billion of foregone revenue, especially when many vital government services are at stake.