Wednesday, November 28, 2012
Back in late October I attended the annual conference held by the National Center on Philanthropy and the Law at NYU. The topic this year was the charitable contributions deduction, and the papers presented there were uniformly superb. So much so, that I've been thinking about this topic off and on ever since.
The charitable contributions deduction is a mess largely because (like tax exemption itself) we have no common theoretical conception regarding why it exists. The two main (and competing) theories are the tax-base theory and the subsidy (or what I prefer to call the "incentive" theory). Under the tax base theory, the deduction under Section 170 exists because donations shift personal consumption from the donating taxpayer to a third party (the charity, or the beneficiary of the charity). The tax base theory is built around the common Haig-Simons conception of taxable income, which is the sum of personal consumption plus savings during the tax year. The tax base theory argues that a donation is neither personal consumption (as opposed to buying a new TV for personal use) nor savings; ergo, it must be excluded from the donating taxpayer's tax base. This "exclusion" happens by giving the donating taxpayer a deduction, since the donation presumably comes from something that otherwise would be "gross income" under Section 61. You will sometimes hear this argument as an "ability to pay" argument - that is, a donation reduces one's "wealth" and hence the person who gives away money to charity has a lower ability to pay taxes than a person who doesn't. But "ability to pay" is grounded largely in the Haig-Simons model of income, and hence I find it preferable to think about this theory on those grounds.
Unfortunately, Section 170 doesn't really embody this theory, however attractive it may sound to some. If we really believed in the tax base theory, deductible donations wouldn't be limited to only organized charities. Note that under Section 170, a donation to a bank fund set up for a local family whose house burned to the ground or whose child is undergoing cancer treatment is NOT deductible, because the donation isn't to an organized charity (e.g., a 501(c)(3) organization, or government). But if you believe in the tax base theory this kind of transfer reduces ones consumptive ability just as much as a transfer to the United Way. Moreover, the tax base theory would not support any deduction for unrecognized appreciation in property - you can't deduct something from someone's tax base if the amount has never been included in the tax base to begin with. And the 50%/30% limitations make no sense under this theory either - if you give away all your income during the year to charity, your consumptive/savings ability has been reduced to zero. Ergo, so should your theoretical tax base.
Another way to look at 170, however, is that it isn't at all about properly defining the tax base. Rather, it is simply a government incentive for people to give money to organized charity. This is actually how most tax professionals and economists view 170. If we look at it this way, the overall structure of 170 makes a bit more sense: if we only want to encourage giving to organized charities (perhaps to avoid some potential back-scratching scams that would occur if we expanded deductibility to the family down the street with the house fire), then 170's limitation to organized charity makes sense. The deduction for unrealized appreciation can be viewed as simply a bigger incentive for people to make charitable gifts of high value/low basis property. The 50%/30% limits are simply a way of the government saying "Some incentive, yes, but not too much." And so forth (even the deduction structure makes a bit more sense: after all, if what you want is to provide an incentive for donations, best to target that incentive at the people with the most wealth to give. The deduction structure provides a greater incentive as your marginal tax rate goes up, which makes a great deal of sense if you want to encourage rich people to part with larger percentages of their wealth).
The problem with the incentive approach, however, is that Section 170 almost certainly is badly inefficient as an incentive system. Here's one example. Empirical studies generally find that donations to churches are much less elastic than for other kinds of charities (for a quick summary, see this 2004 article by Jon Gruber). Studies also show that churches exist largely on relatively small donations from people who are unlikely to itemize deductions, and hence get no benefit at all from the 170 deduction. Put these two things together, and you can see that using 170 as incentive for charitable giving to churches is mostly a waste. It may also be a waste for large donations that accompany "naming opportunities" where the ability to purchase some small slice of immortality may outweigh the tax incentive (though I haven't seen an empirical study on this exact point).
In any event, I am quite certain after having heard their presentation at the NCPL conference that Charlie Clotfelter at Duke and Gene Steuerle from the Urban Institute could craft an incentive system that actually worked and yet was far less wasteful (e.g., would not reduce charitable giving but would recapture a large chunk of tax revenue) than 170 as it currently exists. This also means that the wailing and gnashing of teeth going on in the charitable sector that "the world as we know it will end" if anyone touches the charitable contribution is silly. Huge chunks of Section 170 are hugely stupid when viewed through the incentive lens from an efficiency perspective.
But being sensible about the contributions deduction BEGINS with agreement on the underlying purpose - that is, theory matters. If we could agree on a theory, "blow up" 170 as it exists, and then reconstruct it according to the theory, we'd have a far simpler, far more efficient system. Perhaps it is too late to take this approach to Section 170 given all the entrenched interests involved, but the fiscal cliff negotiations might give an opening to this kind of considered tax reform generally . . . at least, hope springs eternal.