Why the Charitable Deduction Is Unlikely to Change

To get a sense of the odds against the country’s seeing any substantial change in the charitable-deduction rules, you don’t have to look further than this month’s House Ways and Means Committee hearing.

For one thing, most of the witnesses—civil society was out in force—were not much interested in complex economic arguments about the comparative merits of competing plans to change the charitable deduction, along with the rest of the tax system. Instead, these witnesses had a virtually uniform and clear message: Charities need all the money that they get from the current system, and they need it now.

Second, even the witnesses who stepped back from the nonprofits’ testimony to try to evaluate the policy considerations behind the overhaul plans did not provide any definitive guidance. No simple answer, they told the committee, can achieve the competing goals of raising more government revenue while encouraging more giving.

As a result, the prospects for change seem slim because Congress is so divided on questions about what the roles of government and charity should be, and nobody seems willing to engage in tough questions about why charitable giving is a tax-subsidized activity in the first place.

The House hearing on the charitable deduction marked the beginning of another effort to overhaul the tax code, whose last major facelift took place more than a quarter-century ago. Eleven working groups will be studying the effects of large-scale change on different types of people and organizations, including nonprofits.

In a spirit of democratic inclusiveness, Rep. Dave Camp, the Michigan Republican who chairs the Way and Means Committee, announced that the hearing would be open to a sample of all those who wanted to testify. Since United Way Worldwide was holding a meeting of its members in the nation’s capital on the day of the hearing, more than a dozen local United Way presidents showed up.

So did witnesses representing the Association of Gospel Rescue Missions, the Jewish Federations of North America, the Harold Washington Cultural Center of Chicago, the National Association of Free and Charitable Clinics, and more. Their testimony was short on the economics of giving and long on fears that tax-law changes would lead to less money for their efforts.

Nonprofit leaders from across the country told the lawmakers how slim the margin of survival is for many organizations—and why they do not trust ideas to change the charitable deduction.

John Berry, chief executive of the Georgia branch of the Society of St. Vincent de Paul, explained that the 2005 changes Congress enacted to tighten the rules for writing off gifts of cars, trucks, and other vehicles had devastated revenues of groups like his—even though Congress promised nothing of the sort would happen.

Tim Delaney, president of the National Council of Nonprofits, noted that while limiting the charitable deduction might increase the amount of money in government coffers, that would not necessarily mean the money would find its way back to local charities. The pattern these days, he said, is for governments to cut their own budgets and ask nonprofits to provide more social services (while not providing any reimbursement for the new burdens nonprofits take on).

True, the Ways and Means Committee had more material to consider than just the testimony of panicky nonprofits. It also had a report from Congress’s own Joint Committee on Taxation and testimony by several scholars who have examined the charitable deduction.

Those scholars—as well as other economists and lawyers—tend to provide two reasons government should allow a charitable deduction:

• Government is entitled to tax only the income that people can use for their own benefit. When people give money to charity, they give up personal benefits, so government has no reason to tax that income.
• Money donated to charity supports efforts that improve society, so government should provide incentives to maximize such donations.

The first concept raises tough policy questions: For instance, do donors to charity really receive no personal benefit at all? And why should giving be deductible for taxpayers who itemize deductions but not for others?

But many more policy questions arise if the deduction is considered a subsidy meant to produce increased public benefits.

Do we simply want to maximize the overall amount that the country’s individuals and entities give to charity, broadly defined? In that case, any measures to raise more government revenue should be crafted to minimize their impact on total giving. Indeed, government may want to forgo revenue by allowing more individuals to claim charitable deductions.

Or do we want to maximize the amount of private donations supporting functions that government would otherwise be required to support, like the provision of basic social services? In that case, we should raise more government revenue by narrowing the scope of the activities that merit the charitable deduction.

Even if we agree on the broad outlines of our common goals— for instance, that we want to raise more revenue for government and maximize private charitable giving—we have to recognize that these goals often conflict with each other.

Say we raise tax rates from 30 percent to 40 percent but keep the charitable deduction rules as generous as they are now. That means a donor will have less after-tax money to donate. But she will have an incentive to give more—because before the rate increase, the donor saved 30 cents in taxes for every dollar of charitable giving, but after the increase she saves 40 cents in taxes for every donated dollar.

In contrast, if we raise tax rates and also make the charitable deduction rules more restrictive, government may get more revenue, but the donor will have less after-tax money to donate—and no increased tax savings that would make donating more attractive. As a result, charitable giving is likely to decline.

Charitable-giving rates are affected largely by the state of the economy as a whole. Donors, rich and poor, give less when the economy sinks. So we face another challenge: To increase charitable giving by improving the economy, we may have to raise tax rates, even if that means we don’t provide donors with as much in tax savings to encourage them to make charitable gifts.

While economists can supply some answers about what works best, they don’t yet have answers that provide much certainty or reconcile conflicting political views about the role of government and philanthropy. And until lawmakers are willing to engage in a real debate about what the goal of the charitable deduction should truly be, odds are they will instead do nothing after hearing the real-life fears of nonprofits.