September 28, 2011 | Read Time: 5 minutes
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 Richard Steinberg, professor of economics, philanthropic studies, and public affairs, at Indiana University-Purdue University Indianapolis.
The charitable deduction from individual income taxes makes it less painful to give, but donors still make a sacrifice. Therefore, for most people, taxes are not the reason to give; they are a factor affecting how much, to whom, and when to give.
Hundreds of studies show that taxes affect giving, using statistical analyses of natural data or scientifically controlled experiments to produce their conclusions. But people respond in diverse ways, depending on their income and wealth, the kind of charity they give to, and their perceptions of government spending and tax policy. In addition, taxes affect the solicitation efforts of charities in ways that have not been sufficiently studied. We would like to know how deductions affect net donations (donations minus solicitation expenses), but studies to date look only at gross donations. So there is no simple way to summarize what we do and do not know at this time.
I think there is little doubt that taxes affect the timing of giving in two ways:
First, people move their gifts to years when tax policy is most favorable. People who know their income will be much higher next year will postpone their giving to benefit from the anticipated fall in their price of giving. People who believe that the future price of giving will change because of legislated tax reforms will also adjust the timing of their gifts. Two proposals now being discussed (limits on deductibility and increases in capital-gains tax rates) would, if enacted, cause giving to increase before the change, decrease following the change, and eventually settle somewhere between.
Second, tax policy affects whether donors give while alive or in the sweet hereafter. If, for example, Congress allows the Bush tax cuts to expire, restoring bequest taxes and the deduction of charitable bequests, donors will reduce their lifetime giving in favor of a larger charitable bequest.
Tax policy also affects giving after things settle down. The research hasn’t reached a consensus on the size of the effect, but the price elasticity, on average, is close to -1. In words, a 10-percent decrease in the after-tax price of giving would increase total giving by 10 percent, all else held equal.
My opinion has changed over the years as better studies have emerged, and it may change again. We have fewer studies of tax effects on specific kinds of giving, but evidence to date suggests that taxes have a lesser influence on gifts to religion and a greater influence on gifts to secular causes. The evidence is thoroughly mixed on whether high-income individuals are more sensitive to tax treatment than the middle class. Even the best of studies that address this issue fail to include data on Bill and Melinda Gates, Warren Buffett, and a few other multibillionaires. The reaction of one Bill Gates to a tax reform can affect total giving more than the reactions of millions of mere mortals.
Recent evidence suggests that the response of taxpayers to incentives depends on how those donors perceive the incentives. In particular, studies find that donors give more if they think of tax subsidies as matching, rather than rebating, a portion of donations. This means that if we replaced the charitable deduction with a new policy in which taxpayers report their donations and the government sends a matching check to the recipient charities, giving would increase and changes in the match rate would cause larger changes in giving. There are drawbacks to this approach. (Would taxpayers want to tell the government which charities they supported?) Yet this finding raises new possibilities for encouraging giving.
The context of the change in tax policy also matters. Some proposals are revenue neutral, combining a decrease in tax rates with an expansion in the share of income subject to tax. Then the price elasticity is the only thing that matters. Other policy changes increase both rates and total tax collections. These changes create two opposing forces—giving goes up because the after-tax price of giving goes down, but giving goes down because taxpayers have less after-tax income from which to give.
I believe the evidence favors the conclusion that the price effect is bigger than the income effect, so a rate and tax-collection increase would still cause giving to increase. However, we have no studies concerning the elephant currently in the room.
President Obama has called for tax increases, not to increase government spending but to reduce the deficit. Economic theory suggests that deficit reduction has a different effect on giving, for several reasons. Most obviously, there is less need for parents to save money for bequests to their overburdened children who have to pay back the debt. So there is more reason for parents to give to charities. Absent empirical studies, I can only guess at the effect of such a tax increase, but I believe a deficit-reducing tax increase would increase giving more than a tax-and-spend policy would.
