Wealthy Donors Weigh Tax Incentives Heavily When Choosing How Much to Give

Editor’s Note: President Obama has proposed a plan to reduce the value of the itemized deductions that wealthy people can claim for charitable gifts. To help explain the impact of Mr. Obama’s plan, The Chronicle asked four prominent economists to offer their analysis of how a change in the charitable deduction would affect giving. Following is an essay by Jon Bakija, a professor of economics at Williams College, in Williamstown, Mass.

The price of giving a dollar to charity is one dollar less the tax savings from doing so. For example, the price of a $1 donation is only 65 cents for someone in the 35-percent tax bracket who itemizes deductions.

My research with Brad Heim of Indiana University finds that reducing the price of charity by 1 percent increases charitable giving by a bit more than 1 percent. So all other things being equal, the person in the example above donates about 35 percent more than would have been the case in the absence of the income-tax deduction for charity.

Convincing evidence on this question requires a comparison between a treatment group-people who experienced large changes over time in tax incentives—and a control group that plausibly tells you what would have happened in the treatment group had it not been treated by the change in tax incentives. We compare how charitable giving changed over time for people with similar incomes but who experienced different changes in tax incentives over time because of their states of residence.

For example, among people with incomes above $200,000, the price of giving $1 to charity went up by about 10 cents more on average in Texas than in California from 1981 to 1992.

We examine data on more than 60,000 mostly high-income taxpayers from all 50 states and the District of Columbia, each followed from 1979 to 2006, and find that among those living in states where the price of giving went up more, charitable giving declined relative to the giving of similar people living in states where the price went up less.

This implied a significant impact of tax incentives on charitable giving, with each 1-percent increase in the price of charity reducing giving by a bit more than 1 percent.

In previous research, the treatment group was typically high-income people, who experienced big federal tax cuts (and thus big increases in the price of giving) during the 1980s, and the control group was middle-income people who experienced little or no change in tax rates over time.

The problem with that type of comparison is that other factors that strongly impact charitable giving, but are hard to measure given the available data—such as wealth—were changing in dramatically different ways over time for the rich compared with everyone else.

Such estimates are sensitive to how one addresses the problem of omitted variables such as wealth, which may explain the divergent estimates in the previous literature.

By contrast, estimates based on our comparisons of changes over time across states are not very sensitive to how one deals with omitted time-varying factors like wealth, suggesting our estimates are more likely to be picking up the true impact of tax incentives rather than the effect of something else that happened to be changing differently for the rich compared with everyone else.