Could Obama’s Tax Plan Hurt Charitable Contributions?

According to the New York Times and other sources, part of Obama’s plan to pay for his health care initiative involves limiting the availability of itemized deductions for taxpayers with over $250,000 in income (probably we mean adjusted gross income for this purpose, though that detail is still murky). This means that the value of itemized deductions will go down for these taxpayers, and one of those deductions is the charitable contributions deduction.

Many academic studies have concluded that there is considerable elasticity of demand for charitable contributions by the wealthy – or in English, that means that the wealthy in fact respond to tax incentives for donations. If the after-tax cost of charitable giving goes down, the wealthy give more; if it goes up, they give less. Admittedly, these studies vary in predicting the effect of tax changes on charitable giving, and they are all based on statistical analysis and computer modeling from trends observed at times when the economy differed from what we have now. But I think most economists and academics who study the matter would agree that increasing the after-tax cost of donations will have some negative effect on charitable giving, and given the state of our economy and the pressures on charities already, any negative effect may be a bad idea. (Note that there is a counter-argument: some would argue that the tax benefits we give to the wealthy for charitable contributions gives them a disproportionate advantage in shaping the policies of charitable organizations and that in fact tax policy should reduce the tax incentives for giving by the wealthy to avoid having the wealthy monopolize charities).

On a broader note, many tax policy folks (me included) have serious qualms about targeting itemized deductions en masse as a method of raising taxes. At its simplest, I prefer more transparency – if we want to raise taxes on the wealthy (which, by the way, I happen to think is a splendid idea, given that the wealthy have literally made out like bandits from the tax policies of the past 8 years or more and that the distributional inequality of our societal wealth has grown exponentially over that time), then let’s just raise the marginal rate, which affects everyone in that tax bracket relatively equally, instead of attacking itemized deductions, which will result in a varied effect depending on how big a given taxpayer’s itemized deductions are. For example, if I have $500,000 in adjusted gross income and make a charitable contribution of $100,000, my taxable income after the deduction is $400,000 and I would presumably pay the same amount of tax as someone making $400,000 and making no charitable contributions. If we raise the marginal rate, both of us end up paying more. If we disallow the charitable contributions deduction, then I end up paying more (because my taxable income now rises to $500,000), but the guy making no charitable contributions pays the same. In effect, what we’ve done is raise the tax rate on just charitable contributions with this strategy. Now if we really think a deduction for charitable contributions is bad public policy to begin with, well, OK . . . then let’s just end it. For example, a number of tax policy experts feel that the deduction for home mortgage interest causes us as a society to over-invest in housing (particularly really-big houses), and should be ended. I agree. So fine. Let’s end it. But let’s not sneak tax increases through the back door without examining the underlying policies for the deductions in the first place. Better to just raise marginal rates.

(Hat Tip to Harvey Dale)

JDC

UPDATE: Politico.com reports that Peter Orszag was asked specifically about the effect of the budget on charitable contributions at today’s press briefing, and he opined that people contribute to charities “out of benevolence,” not out of desire for a tax write-off. I think this is a bit disingenuous – as I noted above, it may be true that the tax proposals won’t have a huge effect on charitable contributions, but to argue that people don’t respond to tax incentives on this issue is against the manifest weight of the academic literature.