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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, January 18, 2019

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Hemel's The State-Charity Disparity Under The 2017 Tax Law

This week, Mirit Eyal-Cohen (Alabama) reviews Daniel Hemel (Chicago), The State-Charity Disparity Under the 2017 Tax Law, 58 Wash. U. J.L. & Pol'y ___ (2019).

Mirit-Cohen (2018)This Article is especially timely in light of continuous efforts by states (recently by Connecticut, New Jersey, New York, and Oregon) to create state tax credits for charitable contributions to public education or public health. These tax credits reduce the state tax liability for Federal purposes and might be helpful in alleviating the effect of the new cap on individual state and local tax (“SALT”) deductions imposed by the Tax Cuts and Jobs Act of 2017 (and was also part of the 2016 Clinton tax proposal). While the IRS has allowed in the past such charitable contributions as deductible for Federal purposes, Treasury recently proposed regulation to reverse this trend requiring taxpayers to decrease their charitable contribution deduction by the value of SALT benefits received for their contribution, with a “de minimis” rule ignoring state tax benefits worth less than 15% of the donation.

Hemel makes a case against the disparity in the limitations on charitable contributions (up to 60% of AGI) compared to those placed on SALT payments ($10,000 cap a year).  He provides several justifications for removing such differential tax treatment. First, he points out to the fact that both public charities and state and local governments are primarily in the business of providing education, health, and social services. But more so, in Hemel’s eyes, the fundamental reasons for supporting charities such as promoting pluralism, creating positive externalities, and delivering specified knowledge, are equally if not more present in the case of state and local government organizations. SALT can be seen as simply the price of goods and services that state and local governments provide. Accordingly, from a measurement-of-income perspective, Hemel suggests that SALT should represent costs of services only up to a point, after which they constitute a reduction in consumption plus savings. Indeed, today this is encompassed somewhat in the Standard Deduction and will continue to do so with its exponential recent increase in 2018. Taking Hemel’s implicit analogy a step forward could be providing a differentiated Standard Deduction at the Federal level, adjusted for each state for its value worth of services. Ignoring issues of valuation and political brawl, this could be an efficient way to coordinate more equitably the services (measured via local taxes) of each state to their Federal deductibility. 

Thereafter, Hemel relies on Pigou’s famous quote: “government should subsidize activities that produce positive externalities and tax activities that generate negative externalities, with the rate of the subsidy or tax equaling the marginal external benefit or cost.” Hemel acknowledges that the Pigouvian case for the charitable contribution deduction is a solid one that might even support a credit, rather than a deduction that is worth only the amount times the taxpayer’s marginal rate. Yet, he makes a similar case for state and local positive outcomes in education, health, and social services that can justify Pigouvian subsidies, albeit admitting charities do proportionately more of those activities. And if we really want to make sure these externalities will occur, having mandatory payments to state and local providers of such goods (via taxes) can be even a more efficient tool, in Hemel’s opinion. And those who refuse to pay can move to Alaska (or to other jurisdictions with lower SALT). 

Another argument for the charitable contribution deduction that Hemel tackles here is institutional pluralism. Simply put, non-profit organizations serve as safeguards of liberty, incubators of social capital, and mechanisms for minorities to pursue common goals and values. Yet, Hemel’s answer is that these justifications work in a similar if not elevated way in states and localities that provide checks and balances on the national government in the form of local school boards, town meetings, city councils, etc. While this may be so if we assume complete disconnect between local and nationwide politics, one thing to remember is the inevitable association between state and national powers that somewhat weakens the central tenets of Hemels’ argument. 

final effort to employ the justification for charitable contribution deduction to SALT involves the assignment of supervisory powers to private individuals with informational advantages. He applies Saul Levmore, Taxes as Ballots, 65 U. Chi. L. Rev. 387 (1998) (that views charitable contribution deductions as a federal subsidy to well-informed individuals) to the state and local context. He views SALT deduction as allocating capital to groups in society that distribute it to local causes, with increasing Congressional participation the more people participate in the promotion of such causes. Hemel adds that the SALT deduction provides the additional benefit of being “ballots as ballots” by assuming that those individuals (acting in state and local institutions) also have to be part of a transparent and democratic process.

One apparent angle missing in Hemel’s puzzle is the negative externalities associated with both agents of public goods. It seems that private charities and public institutions mutually are subject to deficiencies in transparency, administrability, and straight-forward economic waste. In fact, a private and less rigid non-profit would likely be more efficiently administered and involve less waste of resources compared to heavy-regulated state and local government institutions. When private individuals contribute funds to a non-profit institution they tend to follow its financial decision-making, efficient management, and social goal accomplishment more closely than government institutions that are subject to remote supervision and often suffer from bureaucracy, foot-dragging, politics, and even fraud.  

Here’s the rest of this week’s SSRN Tax Roundup:

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