News and analysis
October 02, 2011

Changes in Charitable Deduction May Have Mixed Impact on Giving

Richard White/Chronicle of Philanthropy

The charitable deduction is once again at the center of political debate.

President Obama, for the fourth time in his presidency, proposed last month to curb the tax break for wealthy Americans, along with all other itemized deductions. He said the money lost to the federal treasury from all those write-offs was needed to pay for his jobs bill, the centerpiece of a plan to revive the economy.

Charities immediately denounced any effort to limit the incentive to give, especially at a time when giving has dropped because of the bad economy.

But how much do tax incentives matter to donors?

To get an independent view, The Chronicle turned to economists to see what they would say.

While scholars have been sparring over the relationship of tax breaks to giving for decades, the one thing they agree on is that there is no easy answer.

People decide whether to give, and how much to give, for many reasons that go well beyond tax savings, they note.

The most recent research suggests that tax incentives do make a big difference in how much individuals give. But Mr. Obama’s plan would affect a small percentage of taxpayers, so some studies have concluded that the impact on overall giving could be relatively modest.

Research also suggests that some charities are far more likely to be affected by a tax change than others—donors who are wealthy tend to support colleges, hospitals, and other big organizations and they are the ones who would most likely change their giving patterns under the Obama proposal.

Greater Urgency

Because so much of the research on the charitable deduction by economists and think tanks is inconclusive, new efforts are under way to get answers. The research takes on more urgency this fall because ideas beyond those suggested by Mr. Obama are likely to get attention.

A new Congressional “super committee” will work to identify how to trim more than $1.2-trillion from the federal deficit over 10 years—and changes in the way taxpayers are rewarded for giving to charity could be part of the solution.

The Senate Finance Committee is also expected to hold a hearing on charitable-giving incentives in mid-October as part of its broader effort to consider ways to overhaul the tax code.

All of this has prompted high-profile groups like the Urban Institute, which has received a $1-million research grant from the Bill & Melinda Gates Foundation, to explore how a change to the charitable deduction would affect nonprofits.

The Center on Philanthropy at Indiana University, which first looked at the potential impact of President Obama’s proposals on the charitable deduction in 2009, also plans to release an updated study next month.

Its verdict two years ago: Giving by people who itemize their taxes would probably have dropped by less than 1 percent if this plan had been in effect in 2006.

To figure out what is known so far about the importance of tax incentives to donors, The Chronicle examined more than 30 studies and interviewed half a dozen scholars. 

 State Incentives

One of the most recent independent studies quantifies just how much of a difference the incentive makes. Two college professors, Jon Bakija and Bradley T. Heim, studied tax data to follow more than 60,000 mostly high-income taxpayers from 1979 to 2006, looking at how similar donors in different states responded to their various state tax incentives.

Mr. Bakija, of Williams College, and Mr. Heim, of Indiana University, tried to strip away other factors that might be influencing people beyond tax policy—such as wealth, social attitudes, and religious commitment.

And since previous research has shown that donors often shift some of their donations from one year to the next when they anticipate tax-law changes, the researchers wanted to follow taxpayers for many years so they could see how their giving changed in the long run.

In a study published in June, they concluded that all else being equal, if the tax savings for giving another dollar to charity goes up one cent, donors will increase their contributions by a bit more than 1 percent. And they will trim their giving by a similar amount if their tax savings fall.

Put another way: If a donor gets a 35-percent tax break for her gift, she will donate about 35 percent more than she would have with no tax incentive.

Influence of Tax Savings

If the plan Mr. Obama proposed last month were to take effect, and if Mr. Bakija and Mr. Heim are right, then here’s what would happen for a donor who gave $1,000 to charity in 2011 and earned enough to be in the highest income-tax bracket.

This year she gets a 35-percent tax break on all of her itemized deductions, including gifts to charity. So her $1,000 in gifts costs her just $650 out of pocket because she receives $350 in tax breaks.

However, if the president’s proposal were to become law, she could write off only 28 percent of her gifts. That means she would save only $280 on her taxes and her donation would cost $720—nearly 10.8 percent more than it did before. Mr. Bakija and Mr. Heim’s research suggests that the donor would probably decrease her contribution by slightly more than 10.8 percent so that her out-of-pocket costs would be closer to those under the old tax law.

So the recipients of her gifts would lose more than $108.

To be sure, the economists say, other factors in her life, including any additional changes made in the tax code, could also affect her decision to give.

Expiring Tax Cuts

If all wealthy taxpayers lowered their donations by the percentages suggested by Mr. Bakija and Mr. Heim, that could cause a significant decrease for groups that get money from the affluent.

President Obama’s proposal would affect taxpayers with adjusted gross incomes of at least $200,000 ($250,000 for married couples) who itemize their gifts. Taxpayers earning at least $200,000 represented 2.8 percent of all people filing tax returns in 2009, according to Internal Revenue Service data. However, they donated 37 percent of the $158-billion in itemized charitable gifts made that year.

Not every wealthy taxpayer would be affected by the proposed limit, however. Some already face a 28-percent limit on itemized deductions because they are subject to the “alternative minimum tax,” a system that seeks to prevent high-income taxpayers from using loopholes to avoid paying taxes.

While the charitable deduction is important, it is not the only tax policy that affects giving.

A 2010 Congressional Research Service report on Mr. Obama’s plan to limit the charitable deduction notes, for example, that he also hopes to increase the capital-gains tax. That, it said, could prompt more people to donate stocks and other assets that would otherwise be subject to the tax because they have grown sharply in value.

At the same time, he has proposed to let Bush-era tax cuts for high earners expire, which would give those taxpayers less disposable income to spend on charity than they have now.

Uneven Effects

Changes in the charitable deduction don’t play out equally for nonprofit groups, say economists, because of the differences in the types of organizations that get support from the wealthy.

In a 1975 study of tax data, Martin Feldstein, professor of economics at Harvard University, and Amy Taylor, now an economist at the federal Agency for Healthcare Research and Quality, concluded that gifts to educational institutions and hospitals were strongly influenced by tax considerations but those to religious groups were not.

After analyzing data about where high earners donate most of their money, the Congression­al Research Service report estimated that Mr. Obama’s plan to limit the charitable deduction would depress giving the most to health organizations, followed by arts and education groups, while donations to charities that help the poor would fall only slightly.

Government’s Role

As policy makers decide what to do with the deduction, they will look not just at the impact on charities but also on federal coffers. After all, every dollar that a donor receives in tax breaks is a dollar less for the nation’s treasury.

Some economists want to know whether tax incentives encourage people to give more to charity than the government loses in tax revenue.

If not, one could argue that it would be cheaper for the federal government to provide the services itself—or to scrap the deduction and give the extra tax revenue directly to charities.

But some analysts warn against giving too much weight to the idea that government should provide those services. Even if that were cheaper, they say, it might not perform them as well.

And in the case of some charities, like houses of worship, government can play no role at all.

What’s more, some economists argue, tax incentives for giving should not be viewed simply in financial terms.

“Aside from whether it has an impact on giving, the charitable deduction is a good idea for other reasons,” says Richard Steinberg, a professor at Indiana University-Purdue University Indianapolis who has studied the impact of taxes on donors. “It recognizes and rewards sacrifices that benefit others.”

Emotional Debate

While researchers scramble in coming months to advise policy makers, one thing is clear: The polarization in Washington will continue to make the debate over the charitable deduction an emotional one.

Soon after Mr. Obama came out with his latest effort, Rep. Eric Cantor, the House Majority Leader, called the idea a “tax on soup kitchens” and vowed to defeat it.

Two days later, Melody Barnes, a White House aide, wrote on a blog item saying that nonprofits, along with other employers, would benefit from the jobs bill—but that somebody has to pay for it. “All Americans will have to pitch in,” she said.