Predicting the Impact of Changing Tax Treatment of Charitable Contributions
By Joyce M. Underwood, CPA
Economic and political pressures are threatening the long-held tradition of taxpayers receiving tax benefits in exchange for supporting charitable organizations. Under recent tax reform initiatives the government is weighing the cost/benefit of tax deductions for charitable contributions by attempting to measure the impact these deductions have on overall tax revenue, the worthiness of donors in certain income classes receiving incentives for giving gifts, and the charitable benefits provided by charitable organizations.
Our government’s support of tax deductions for contributions reduces government resources. So the true cost is hard to measure. Although tax deductions are a means to encourage charitable giving, they reduce government revenue and may benefit certain classes of taxpayers over others. In this difficult time it should not be forgotten, however, that charitable organizations are also in need of revenue as they serve vital public needs and in recent years have been strained by increased demand for services and decreased support from donors due to the tough economic challenges facing our country and the world. Charitable organizations reduce the burden of government by supporting those the government would need to support without charities’ help, and also support needs that would not be met without public interest and support. Also, many argue that charitable organizations can respond more quickly and operate more effectively to address urgent public needs than the government can.
At a Senate Finance Committee public hearing in Washington, D.C., Oct. 18, lawmakers and witnesses proposed modifications to the deduction for charitable contributions as part of tax reform. Many testified to the impact such provisions would have on the government, the charitable community, and donors. In preparation for the hearing, Joint Committee on Taxation (JCT), Present Law and Background Relating to the Federal Tax Treatment of Charitable Contributions (JCT-55-11) (the JCT Report) was prepared. In light of the tax reform efforts, the report considers the interplay between charitable giving and federal revenues, and attempts to evaluate how the current system might be impacted by changes in the tax treatment of contributions. The 36-page JCT Report summarizes the history and evolution of the charitable deduction, started in 1917 when the government raised income taxes to fund World War I efforts and wanted to ensure individuals still had funds to support charities. Historically the viewpoint was that the support of charities decreased the need for government resources and could help avoid further tax increases. Thus the government support benefited both parties and was seen as beneficial by keeping tax rates reasonable.
The JCT Report provides background on the current law and evolution of the tax incentives around charitable contributions, including the impact of the charitable deduction on the income tax liabilities of individuals, corporations, trusts and estates. The rules are complex and not everyone enjoys the benefit of the tax deduction. Deductions also differ depending upon the type of organization and type of property given. It is reported that the cost to the federal government of the charitable deduction to the federal government is expected to be $38 billion in 2011, with more than $11 billion of the benefits of the deduction going to high-income households. The JCT estimates the impact on government revenues between 2010 and 2014 to be about $230 billion.
The JCT Report is not just a primer; it discusses economic behavior. After considering the financial incentives one must consider the personal incentives to giving. The tax deductibility of contributions reduces the economic cost to the donor, but there are a number of different rationales to support the deduction depending on one’s view of the roles of charitable organizations and the benefits they provide to society as a whole, as well as the individuals’ motivations for giving. The study speculates that some donors are motivated by the satisfaction of doing a good thing and helping others and that they do not benefit personally; and also that charitable gifts alleviate the burden on government. If the deduction incentive was not given, the government would have to provide the benefits at full cost rather than at the reduced incentive percentage. Also, there is thought to be a spillover from services provided to the public. For example, charities providing vaccinations provide direct benefits, but also benefit the general public by reducing the spread of disease to others not directly benefiting from the contributions.
The Congressional Budget Office (CBO) also released a study in May 2011 at the request of the House Budget Committee entitled Options for Changing the Tax Treatment of Charitable Giving. This study examines the patterns of individual charitable giving and how different tax treatment of contributions might affect the overall amount of donations, the cost to the government, and benefits provided to the different income groups. Motivations can be different and different income groups support different types of organizations. Low-earning individuals tend to support churches while high earning individuals tend to provide greater support of education and the arts.
Options for deduction floors, nonrefundable credits and fixed dollar percentage amounts are grouped into four categories by the study:
1. Retaining the current deduction for itemizers but adding a floor
2. Allowing all taxpayers to claim the deduction, with or without a floor
3. Replacing the deduction with a nonrefundable credit for all taxpayers, equal to 25 percent of a taxpayer’s charitable donations, with or without a floor
4. Replacing the deduction with a nonrefundable credit for all taxpayers, equal to 15 percent of a taxpayer’s charitable donations, with or without a floor.
For each of the four categories, CBO analyzed two potential floors: a fixed dollar amount ($500 for single taxpayers and $1,000 for couples filing a joint return) and a percentage of income (2 percent of AGI). Only contributions in excess of the floor would be deductible or eligible for a credit. The analysis uses data for 2006, the most recent year for which the Internal Revenue Service’s public-use sample of individual income tax returns is available. The tax treatment of charitable contributions is generally the same today as it was in 2006; however, because of rising incomes and contribution amounts, the options that include a fixed dollar floor would have a somewhat different impact today than presented here.
The CBO report summarizes the impact of changes in the different categories, but the results do not reflect behavioral assumptions that are included in the JCT analysis. Thus, the CBO report is meant to highlight the general effects of the various approaches. The actual effects of a change would differ based upon the specific parameters of a policy.
Charitable organizations can reduce the burden of government. Incentives cost revenue, but motivate action. Shifting the incentives among income groups can result in different allocations of donations among types of charities.
So questions remain:
• Can we afford a reduction of donations from high earners?
• Will lower income earners respond to incentives?
• Can we truly measure the response to a major change in tax law in such a complex area?
• And, finally, is the government prepared to respond to the potential financial burden of providing social services presently borne by charities if government revenue increases at the expense of public support of charities?
All these questions remain unanswered at this point. It is therefore difficult to measure the true cost of government’s support of tax deductions for contributions and the impact a major change would bring to the economy and budget.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Winter 2012). Copyright © 2012 BDO USA, LLP. All rights reserved. www.bdo.com