Thanksgiving week marks the traditional start of the holiday season, when our thoughts should turn to those less fortunate than ourselves. Most charities aimed at helping others report their heaviest donations during the holidays, and not only because of the urgent reminders besieging us on every side.
As the end of the year approaches, families measure out their remaining disposable income in order to decide how much to contribute during the great year-end giving binge. And one of the things most people take into account is the tax deductibility of their donations.
Maybe in a perfect world nobody would worry about whether gifts to a particular organization were tax-deductible. In the imperfect world in which we live, however, charities fight to preserve their 501(c)(3) status, and with good reason: The deductibility of contributions affects people’s willingness to give.
This proposition is a useful starting point for analyzing the rising mania among politicians on both sides of the aisle to adopt a policy long popular within academic circles -- either eliminating or severely restricting the charitable deduction, at least in the upper-income brackets. For some, this would be part of a larger tax overhaul, reducing rates in return for capping or abolishing various deductions. For others, the idea is simply to tap a pot of gold that seems to be lying there, while leaving most of the current structure of the tax system intact.
Venerable Tax Law
By all accounts, the pot is a big one. According to the Obama administration’s budget estimates, the amount by which itemized contributions reduce the personal income tax will total about $53.7 billion in fiscal 2011, and about $315.1 billion over fiscal years 2011-2015. That is a lot of money, and it is a natural place for a cash-strapped federal government to look for revenue. Natural, but mistaken.
The deduction for charitable contributions is one of the oldest in the tax laws, dating back to the War Revenue Act of 1917. Congress understood from the start that it was creating an incentive to give. Senator Henry Hollis, a New Hampshire Democrat, explained during the debate that people contribute to charities “out of their surplus” -- after paying other bills - -and, therefore, in difficult times would contribute less. Without the deduction, he said, charitable donations “will be the first place where wealthy men will be tempted to economize.”
The theory behind the deduction, as Representative Carl Curtis, a Nebraska Republican, noted during World War II, is that charitable giving is “exempt from taxation” because it represents “an expenditure for the public good.”
Curtis had it right. Charitable giving represents spending for precisely the same purpose that the government spends: to promote the general welfare. The difference is that the individual who gives to charity might measure the needs of the community by different calipers than centralized policy makers, and will therefore contribute to a different set of causes.
These millions of individual decisions lead to a diversity in spending that would be impossible if we adopted the theory that the only money spent for the public good is the money spent by the state.
Democrats and Republicans alike have come to refer to the charitable deduction’s “cost” to the government. This language, however, only makes sense if one concedes that government has first call on every dollar earned in America. It isn’t obvious why this starting point is the correct one. It is just as easy to begin with the proposition that the earner owns the money, in which case it is the removal of the deduction -- or the tax itself -- that is a cost.
Opponents of the charitable deduction argue that it is regressive because it benefits those in high brackets more than those in low ones. This is trivially true, as it is of all tax deductions. An earner in the 35 percent tax bracket who gives $1,000 receives, in effect, a $350 subsidy. The earner in the 15 percent bracket who gives the same amount receives a subsidy of only $150.
Deduction Isn’t Regressive
But the argument once more misunderstands the purpose and function of the deduction. Its principal beneficiaries are not those who give, but those who receive. If I donate money directly to a local soup kitchen rather than requiring it to wade through the layers of paperwork and volumes of regulation required for obtaining even the mere chance of a direct government subsidy, everyone is better off -- especially those who eat there.
If the regressiveness truly worries us, we can transform the deduction into a refundable tax credit -- a solution that would, of course, “cost” the government more. Severely restricting the deduction, on the other hand, might make it even more regressive, as charitable giving shifts from the realm of income reduction to that of estate planning: The wealthy woman will still provide for her alma mater after her death, to reduce her estate tax, but the man of high income who isn’t wealthy will be less likely to give.
Already -- presumably due to the difficult economy -- total itemized charitable deductions decreased from $161 billion in 2008 to $148.6 billion in 2009, the most recent year for which comprehensive Internal Revenue Service data are available. (Note that these figures represent the amount of the deduction, not the amount of the “subsidy.”) Reducing deductibility will decrease these amounts further.
It is true that people make contributions for reasons other than saving on their taxes, but to suppose that eliminating the deduction will have little effect on donations at the margin is as silly as assuming that eliminating the home-mortgage deduction wouldn’t depress housing prices because people have other motives for buying homes.
Consistent research over the years has shown that charitable giving, whatever the other incentives, is price- elastic, at least in the higher tax brackets, where giving disproportionately takes place. (According to IRS figures, those with incomes of more than $200,000 gave $49.6 billion of the reported $148.6 billion in charitable gifts in 2009 -- or about one-third -- despite making up only 4 percent of U.S. households.)
The price of a gift rises when the value of the deduction falls. If a taxpayer in the 35 percent bracket makes a $1,000 contribution, the “price” is only $650, because of the $350 deduction. Should his deduction be capped at, say, half its nominal amount, then the deduction is only $175, and the “price” rises to $825. Should the deduction be eliminated, then the price of the $1,000 contribution is $1,000. It is difficult to imagine a universe in which this rising price would have no effect on consumption of a good.
A common counterargument is that the charitable deduction represents an indirect subsidy for religious organizations, and thus violates the separation of church and state. The constitutional scholar in me finds the argument unimpressive, but let us put that aside. The data suggest that the proportion of charitable giving to religious groups is highest in the lower brackets, where hardly anyone itemizes. In the higher brackets, the giving is far more common to educational and other nonreligious charitable entities. In other words, the giving to religious organizations is the least likely to be affected by limiting the deduction. Everyone else would suffer.
The charitable deduction also helps resolve an information problem: Government officials, no matter how well-intentioned, cannot know all the places where donations are needed, or the form that will be most useful. The deduction is democracy in action. By encouraging individuals to make their own choices on how to spend money for the public good, the deduction makes society as a whole better off. Let’s keep it that way.
(Stephen L. Carter , a novelist, professor of law at Yale University and the author of “The Violence of Peace: America’s Wars in the Age of Obama,” is a Bloomberg View columnist. The opinions expressed are his own.)
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