Paul L. Caron

Friday, November 25, 2005

Tax Foundation Questions Desirability of Charitable Deduction

Tax_foundation_11 The Tax Foundation on Wednesday released a new study, Charities and Public Goods: The Case for Reforming the Federal Income Tax Deduction for Charitable Gifts, by Andrew Chamberlain & Mark Sussman.  Here's the description from Tax Policy Blog:

From the perspective of economic efficiency, it turns out it's hard to justify the current size and scope of the federal charitable deduction. Most 501(c)(3) public charities now benefiting from the deduction are neither charitable, in the sense of relying mostly on altruistic gifts, nor are providers of what economists call "public goods."

Here are two charts that tell much of the story. First, the charitable deduction's benefits are highly regressive:

Charity1 [click to enlarge] 



Second, most 501(c)(3)s actually rely mostly on program revenues—e.g., tuition from college students or admission fees at art galleries—and government grants for funding, casting doubt on the notion that they wouldn't be privately provided in the absence of a federal tax subsidy for them:


[click to enlarge] 


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Tracked on Nov 25, 2005 1:07:51 PM


Can I please put in a plea for the "mend it, don't end it" school of thought on the tax-deductibility of charitable donations? Yes, all of the authors' points about hospitals and colleges are valid, and I'm all in favor of ending the deductibility of donations to those institutions.

On the other hand, while I'm horrified that only 6.5% of charitable donations go to human services organizations, as somebody responsible for fundraising for one of those, those organizations NEED their donors to have that tax deduction. Most of the food pantries (the type of not-for-profit I work for) in my area are getting by by the skins of their teeth and having to turn away clients who direly need the help, because of a lack of resources--and this is a relatively affluent area. I can't even imagine the situation in poorer parts of the country. Anything that reduces donations at all--and ending the tax-deductibility of donations definitely would--is going to mean more hungry, cold people this winter. Can the tax-deductibility rules be revised to help funnel donations away from the hospitals/colleges/National Geographic Societies and towards the charities that actually DO charitable work, like food pantries? And not just eliminated? Please?

Posted by: Jules | Nov 26, 2005 5:47:41 AM

It is entirely possible that arts organizations could survive without the charitable deduction, but the analysis provides is quite weak is understaning what role donations play in "high culture" organizations.

The reason that operas are organized as non-profits, while movie theaters aren't, is that the only way an opera can survive is with price discrimination. If you charge anything close to what the marginal ticket buyer will pay for an opera seat for most of your seats, the whole edifice collapses. But, there happen to be some very wealthy people out there who are willing to pay far more than the price of season tickets to keep the institution of the opera alive in their city, but who don't want to feel cheated by simply paying an outrageous price for their tickets. So, their additional payment is structured by a donation and highly praised as civic minded. If the opera were organized as a for profit entity, those donors wouldn't be willing to risk making their donations, for fear that their money would be diverted to private investors or promoters. But, if it is a non-profit, then they can be comfortable that the money is unlikely to go to senior management or some class of investors.

In contrast, because a movie can make a profit even if everyone is charged more or less the same price, with the only meaningful price discrimination being lower price second run and video offerings, they don't need donations, and as a result, don't need to operate as non-profits.

Most high culture non-profits, from theater, to art museums, to NPR, to public television, to symphonies, to ballet companies follow the same economic model. Likewise, many private educational institutions rely on donations, both from parents of current students, willing to pay more in the form of fundraisers and charity auctions, and former students who, in effect, feel that they underpaid for their tuition given the benefits that they received and make alumni donations, for a significant part of their operating revenues.

For most of these organization, the downsides of nonprofit status, like entanglement with government regulations, are no big deal, and the encouragement to high net worth donors to give is a meaningful benefit (although the estate tax charitable deduction is probably even more important).

In contrast, for religious organizations, the costs of government regulation, such as a prohibition on lobbying and the need to document donations, can be quite high in terms of their natural program, which is to spread a particular worldview and ideology. And, religious organizations more than many high culture non-profits, don't receive their proportionate share of benefits from the charitable deduction, since a far larger proportion of their operating revenues come from non-itemizing parishioners, as opposed to high net worth individuals who deliberately overpay for cultural institutions that they want to keep alive.

Posted by: ohwilleke | Nov 25, 2005 8:51:52 PM

It must be very funny (funny weird, not funny ha-ha) to live in a world like that of the authors of the cited study, in which scientific research organizations and civil rights organizations are the paradigmatic charitable organizations. Most charitable giving goes to churches, and it always has. Of course, most of this charitable giving is not deducted, since it comes from people below the threshold where itemizing makes sense.

Posted by: y81 | Nov 25, 2005 5:16:55 PM

"Second, most 501(c)(3)s actually rely mostly on program revenues—e.g., tuition from college students or admission fees at art galleries—and government grants for funding, casting doubt on the notion that they wouldn't be privately provided in the absence of a federal tax subsidy for them"

I don't see how this follows in the least.

"First, the charitable deduction's benefits are highly regressive:"

If the deduction is for goods that the giver would have otherwise thrown out (like much of what goes to Goodwill), I agree. But there is no real benefit to onesself when giving cash to a true charity. The benefit is to those the charity serves. I give a portion of my income to charity. If there was no deduction, I would only be able to budget give that much less.

Posted by: Tom | Nov 25, 2005 1:51:46 PM

I would be interested to see what portion of endowment funding from these institutions comes from private donors versus program fees and the like. Also interesting in the graphic is the 11% from "other". If this represents earnings from the endowments of major institutions, it may be more accurately counted as part of the private donors slice than linked to regular programming.

Another interesting element would be to look at volatility of funding. I would expect that many charities would be hard hit by economic downturns without endowments to help them through. The stability of the institutions would seem important.

Rather than focusing just on the tax deductibility of contributions, it would be useful to look at the scope and types of institutions getting to operate in a tax-exempt status. For example, exempting the educational mission of a large university from taxation might make sense, but should dormitories and cafeterias, university publishing houses, etc. all be exempt as well? These ancillary uses can take up large amounts of real-estate, starving the cities they operate in of property tax revenues. Similar issues for the large land holdings of some religious denominations. Maybe some of these holdings should be subject to tax -- at the very least when they are sold.

Posted by: DK | Nov 25, 2005 12:31:26 PM

Having been on the Board of Directors for multiple 501c3 organizations, I've seen firsthand a lot of what you are talking about. A close friend was a BoD member of one of the national organizations that are notorius for their use of (mandatory) college student fees as well. The appeal of tax deductable donations early on makes them seem like a must have for the survival of these organizations. But as experience grows, it has become all too clear that the deductions don't serve their purpose and aren't actually needed for the vitality of public orientied nonprofits. As long as the tax exemption status of nonprofit corporations is maintaned, eliminating or revising the tax deductable donations status would be a good step forward. At the same time, it would probably be wise to revisit the question of how much foundations are required to give out each year in order to maintain their own status.

Of course, I'd like to see our tax structure move more towards a model similar to the DeMint tax reform plan... so what do I know?

Posted by: J.Kende | Nov 25, 2005 11:59:17 AM