September 26, 2012
In 1917, just four years after the U.S. levied a permanent income tax, Congress gave people the right to deduct charitable contributions from their taxable income. In 2013, when Congress sits down to debate tax reform, the odds of curtailing much less eliminating that deduction stands about as much chance as repealing the income tax code itself.
What other deduction unites in coalition the nation’s hospitals, universities and major foundations? Brings together low-income charities, high-toned arts palaces and conservation and environmental groups? Makes colleagues in action out of the church on the corner, the local museum and the YMCA?
The stitch work of that 1917 decision is reflected in the fabric of every community. The U.S. non-profit sector, arguably the most dynamic in the world, is comprised of over 1.6 million institutions; generating $750 billion in economic activity or 5.5 percent of gross domestic product (only 13 percent comes from donations; the rest comes from activity revenue, government grants and endowments); and employing 13.5 million people or about one out of every ten American workers.
The Internal Revenue Service reports that Americans deducted about $170 billion in charitable contributions in 2010 resulting in about $40 billion reduced taxes. About 80 percent of the tax deductions went to households in the top 20 percent of the income distribution.
When President Obama proposed curtailing all tax deductions by slapping a 28 percent cap on their value for people in higher tax brackets, institutions in the non-profit sector – many of whose leaders and employees would consider themselves natural allies of the Democrat in the White House – rose up as one to oppose the move. “It was the most active coalition we’ve had,” said Diana Aviv, president of the Independent Sector, whose membership ranges from the United Way to the YMCA to the Salvation Army. “Environmental groups, arts and culture, higher education, it brought everyone together. They know it will result in their getting less money.”
One can almost hear the “but, but, but . . .” from the tax policy wonks and economic purists, who have engaged in a running debate for half a century over the wisdom of the charitable deduction. Their first complaint is about fairness. Like most major tax breaks, one must itemize deductions before claiming contributions to charity. That immediately eliminates about two-thirds of all income tax filers.
Revenue of Charitable Organizations by Source, 2009
||Billions of $
|Tax Deductible Private contributions
|Private payments (program service revenue)
|Government grants and payments
|Other Revenue (member dues, special events, etc)
| Does not include small organizations that do not file Form 990s with IRS or religious organizations|
|Source: National Center for Charitable Statistics|
Surveys show low and moderate-income people earning less than $100,000 a year give nearly as much of their income charity (about 2 percent) as either upper middle-income people (around 2.4 percent) or high-income people (around 3.2 percent, according to a Congressional Budget Office report). Yet most households earning less than $100,000 a year usually do not itemize so they don’t get to deduct those contributions.
Moreover, when low- and middle-income people do claim their charitable deduction, they receive less credit from the government because they are in lower tax brackets. A wealthy person’s $1 contribution to the local YMCA reduces his taxes by 35 cents (assuming they are in the 35 percent tax bracket); a middle-income person’s $1 contribution receives 15 or 20 cents (assuming they are in the 15 or 20 percent tax bracket).
“From a fairness perspective, we should make it a credit so your taxes go down by the same amount when you give a dollar whether you’re rich or poor,” said Bradley Heim, an economist at the University of Indiana.
On the other hand, his research also shows high income people are highly responsive to the charitable tax deduction. The larger the tax break the more likely they are to give to charity. The latest studies have upended a previous consensus that suggested well-to-do giving would not change much if the charitable deduction were lowered.
“If the purpose is to increase charitable contributions, then you want to target it to people who will be more responsive,” Heim said. The contribution rates of “high income peoples tend to be more responsive than lower income people” to the deduction. Z
The non-profit sector has seized on these latest studies to make their point on Capitol Hill. “The American people are a generous people,” said Aviv of Independent Sector. “But if they are not incentivized, people will give at a lower level.”
Sometimes the well-off can get two tax breaks out of a single deduction. When someone gives stock to a charitable institution, they get the current value of the stock as a deduction from current income. However, if they don’t sell the stock before giving it away, they don’t have to pay the capital gains if the stock has increased in value since they bought it. “You not only get the deduction, but you don’t have to pay the capital gains that you otherwise would pay,” said Joseph Rosenberg, a research associate at the Urban/Brookings Tax Policy Center.
When the Democrats controlled the House, they asked CBO for a list of options for reining in the charitable deduction, which the Joint Committee on Taxation says will reduce government tax collections by about $246 billion over the next five years. CBO suggested setting a floor below which contributions would not be tax deductible or replacing the deduction with a non-refundable credit that would be capped at either 15 or 25 percent of total charitable contributions.
Yet tax policy experts don’t hold out much hope for it going very far, given the virulent opposition from the nation’s non-profit sector. “It’s reasonable to think it should be on the table,” said Rosenberg of the Tax Policy Center. “But even the Buffett rule exempted it, so there’s a lot of political support for keeping it.”