March 07, 2017

Beyond the Charitable Deduction: How Congress Can Spur Giving

Adam Niklewicz, for The Chronicle

Ever since President Trump took office, charities have been worrying about the tax overhaul he has promised.

There are reasons for concern any time a new administration takes office. After all, the federal government’s subsidy of charitable giving, at a cost to the Treasury of roughly $57 billion a year through individual income-tax deductions alone, represents a tempting pot of funds to finance White House spending and tax goals. President Obama, for instance, repeatedly tried to reduce the value of all itemized deductions, including those for charity.

But new administrations can also present opportunities. Rep. Kevin Brady, the chair of the House Ways and Means Committee, says his goal is to ensure that a tax overhaul unlocks more charitable giving.

Taking him at his word, nonprofits should be thinking hard about how to reshape public policy in ways that would do just that.

Traditionally, the nonprofit approach to tax policy has been defensive: "Don’t touch the charitable deduction. Don’t change the payout rate for foundations."

That type of stance doesn’t work very well when government is looking at bigger-picture issues of how it collects and spends money. Charities often bear collateral damage from the pursuit of other objectives that may have considerable merit, such as a cap on tax breaks, simplifying the tax code, or creating a leaner government.

For example, with little change in the charitable deduction per se, the tax plan Mr. Trump advanced during his presidential campaign would reduce giving by 4 to 9 percent, according to estimates calculated by my colleagues and I at the Tax Policy Center.

But it’s important to keep in mind that only the status quo insures no losers or costs to anyone. Thus, trying to protect all charities from any loss effectively comes across as a case against tax-code changes of any type. That’s not an argument that carries much weight these days.

Nor does the public end up with good policy when legitimate debates on national priorities fail to step beyond fights over the interests of specific organizations or those that work on specific causes. The leaders of nonprofits and foundations must keep their focus on the people they serve — the same ones who might be helped or hurt by everything else that is changed in the tax code.

Looking through that prism, it’s helpful to examine the arguments Mr. Trump and others have made that a significant move to lower tax rates would promote strong economic growth, and that this boost in income would put a lot of people in a position to increase their giving.

If done well, a move toward leaner government can promote growth. But it’s asking a lot of beneficiaries of charitable activities to take a hit when they may not be among the beneficiaries of the tax cuts. For instance, if affluent people benefit the most from growth, will they give more to soup kitchens and job-training programs or to art museums and elite colleges?

What’s more, whether government becomes leaner and promotes economic growth depends not just on tax policy but on whether tax changes are accompanied by efficient spending and budget policy.

But economic growth in dollars and cents isn’t all that’s at stake here. Shouldn’t we also be concerned about the role of nonprofit institutions in any economy, whatever the future growth rate? A permanent cutback in share of income given to charity would make the nonprofit world weaker relative to the economy as a whole and likely increase the extent to which people turn to the government for help.

As a nation, we’re about twice as rich as we were when Ronald Reagan was elected president. Would we have been happy if along the way our generation had become less generous, with the excuse that we still give more in absolute dollars than our parents’ generation?

So, while we need to amend or get rid of charity tax breaks that don’t work well, we must also press policy makers to take steps that strengthen giving as a share of personal income.

Here are some ideas that would do just that:

Allow all taxpayers to claim a deduction for contributions above some minimum.

Today only people who itemize — about one-third of those who file individual tax returns — can claim a deduction. A universal charitable deduction would help make up for the potential losses in giving caused by other changes in the tax code.

Moreover, making a deduction more universally available would send a strong signal that charities matter to our society and that giving is a responsibility that everyone should take seriously. It defines who we are both as individuals and as a people.

Fundraisers might get an additional boost from tax-related appeals, since now the same message could be aimed at all taxpayers, not just those in the upper income brackets who itemize. By way of a reverse analogy, at one time all workers were eligible to make tax-deductible deposits to IRAs. When the 1986 tax-reform law limited those who could take advantage of this provision, deposits fell among those still eligible, not just those newly ineligible. (This reflects the fact that financial firms that market IRA accounts had less incentive to do so.)

While the symbolism of a more universal deduction could sharply increase giving, most estimates suggest only a moderate impact, since people who don’t itemize provide about 18 percent of total contributions to charity every year.

However, this change can be done in a way that would increase giving with minimal or no loss in revenue to the federal government.

Most people give something regardless of whether it involves a tax break, but for amounts above a certain base they start responding to the possibility of getting back, say, $25 for each extra $100 they give. If Congress allowed people to deduct just the amount over 1 percent or 2 percent of income, it could save the Treasury some of the cost for that share of giving likely to take place anyway — and the money could instead be spent on providing charitable tax incentives for the majority of taxpayers who now have none.

That kind of floor also gives a gentle nudge to people who might not want to see themselves as "below average" in their generosity.

Beyond the motivation to donors, any proposal to expand giving must take into account the Internal Revenue Service’s limited ability to monitor giving, particularly the small amounts from taxpayers who give less than 1 or 2 percent of income.

Extend the deduction for all gifts made by April 15, not December 31.

For over a quarter-century, I have suggested that taxpayers be allowed to take charitable contributions for the previous taxable year up until they file their tax returns or April 15, whichever is earlier. In 2015 the House of Representatives passed a similar provision.

No taxpayers have on hand the information at the end of December to fully calculate their income-tax situation. Many do not fully understand just how significant a tax benefit they would get until they are ready to file their forms.

What’s more, hundreds of thousands of tax preparers would almost certainly market, at no cost to charities, the value of making additional contributions. Tax-software developers, in turn, would include this information as they walk taxpayers through preparation and likely would compete in highlighting this opportunity.

If I am wrong, the Treasury wouldn’t bear any extra costs because no additional deductions would be taken. If I am right, the Treasury would lose roughly only 10 cents to 40 cents for every dollar contributed to charity. Almost no charitable incentive has so low a cost to federal coffers compared with the amount of giving it would stimulate.

Create a better donation-reporting system to reduce tax cheating.

The charitable deduction as currently administered cannot be easily enforced.

When your bank or mutual fund sends a 1099 income report to both you and the IRS, you know that you would get caught cheating if you understated your interest or dividends on your tax forms. IRS research bears that out: Only about 7 percent of this type of income is underreported because it is accompanied by some type of third-party evidence.

But when the requirements are less strict and no third party provides reports that the IRS can match with information on tax returns, error rates are much higher, sometimes exceeding 50 percent.

To be sure, charities now provide receipts to people who give at least $250, and that probably helps cut down considerably on errors and abuse. Still, there’s almost no doubt that there would be major improvement if the IRS could do computer matches on a significant share of charitable contributions. Given extraordinarily low audit rates, the current system remains ripe for cheating, but some charities have been reluctant to take on the burden of providing information returns to the IRS.

There is a possible way out of this bind. Why not offer a bonus deduction of, say, 2 or 3 percent exclusively for gifts on which charities report to the IRS? I’m fairly confident that many charities would line up to help their donors get the bonus, and the gains from reducing the number of illegitimate claims for charitable deductions would far exceed the cost of the bonus. With additional revenue, the federal government could support other policies that would increase donations. And it would be a fairer system regardless.

Make it easier for everyone to give from IRA accounts.

If the purpose of allowing people to give from IRA accounts is to make it easier to support charities, why do we restrict the option to people who are older than 70 1/2? If we started people giving younger, they would get in the habit of doing it and the total amount each person donated to charity would probably be higher.

What’s more, let’s relax all the restrictions other than a cap on the amount so the option is fairly universal for almost all IRA withdrawals. This would make it much easier for mutual funds, brokers, and others to provide this service in as automatic and seamless a fashion as possible.

Reduce and make simpler the excise tax on foundation investments.

It’s long been established that the foundation excise tax of either 1 or 2 percent of income is a very inefficient instrument that sometimes penalizes higher levels of grant making. It was designed as a tax on investment returns that foundations would pay to cover the IRS’s costs for monitoring tax-exempt entities, but Congress has never allocated money in this way. Every dollar spent on the tax represents one less dollar for charitable beneficiaries. It’s time to change this tax to a simple flat rate of 1 percent so it no longer takes so much money away from charity.

Encourage charitable bequests.

Congress and Mr. Trump are likely to reconsider the estate tax. In 2017, it effectively gives an individual a $5.5 million exclusion ($11 million for a married couple) and then a tax rate of 40 percent above that amount.

If very wealthy individuals are to be allowed to pass on large amounts of their fortunes without paying an estate tax, then some tax could be collected through a levy on the capital gains they were never taxed on in their lifetimes.

But even that option establishes a tax rate far below what most workers pay on their earnings. We must still find incentives to encourage the richest Americans to remember they have substantial obligations to the society that made their wealth accumulation possible. Perhaps we might add a requirement that to pay absolutely zero estate tax, a wealthy American couple could pass on up to $11 million to heirs, but beyond that amount they would have to put at least 50 percent of the excess into a charitable bequest. (Lifetime gifts would be added to both the measure of gifts given and of wealth).

This is the type of discussion we should be having — finding ways to strengthen government and charities at the same time. And to make it clear to Congress that this should be a priority, nonprofits should insist at key stages in deliberations that lawmakers receive estimates of how much all the tax changes they are considering would increase or decrease giving as a share of taxpayers’ income. The Joint Committee on Taxation already has to estimate changes in giving to figure out the net impact on federal revenue of any tax bill. Let’s share those results so that lawmakers and the public can assess the best way to treat charities in a new tax system.

As this and future tax debates arise, nonprofits must do all they can to get out of their defensive crouch and remind lawmakers and the president that changing tax policy can be done in ways that enhance, not reduce, the good works this country depends upon.

Eugene Steuerle is co-founder of the Urban-Brookings Tax Policy Center and has worked on tax-overhaul efforts at the Treasury Department.