Friday, November 30, 2012
Last summer, several newspapers, blogs, etc. picked up on this article written by Dr. Ryan T. Cragun and two of his students, estimating that tax breaks for churches and other religious organizations cost government $71 billion per year, and like many other crazy things on the web, this doesn't seem to want to go away.
Simply put, the $71 billion number has some very serious problems.
Dr. Cragun gets $35 billion of his $71 billion number by taking the estimated donations to churches from a 2009 survey by Giving USA of $100 billion, and applying the 35% corporate tax rate to that. But anyone with even a smidgen of knowledge about tax law knows this isn't the way it works. We don't have a tax on GROSS INCOME; rather, the tax is on net income.
If churches were treated as taxpaying businesses, then they also would get to deduct their operating expenses and depreciation from their gross revenue in order to reach a taxable income number. Because churches don't have to file a Form 990 or any other financial report, no one really knows what their "net profits" are, but I can verify that the several Catholic parishes I have belonged to during my life have had essentially zero net profits: they spent almost all their revenues on operating expenses, except for the occasional capital improvement (a new parish center or church renovation) which would produce depreciation deductions over time. In other words, churches wouldn't have $100 billion of taxable income; their "profit" after operating expenses probably is close to zero in most cases.
But let's assume I'm wrong, and churches have pre-tax profits equal to, say, the average pre-tax profit margin of the S&P 500 for the past twelve years. That pre-tax margin appears to be something like 9.2% (this story notes that the 12-year average net profit margin has been about 6%; if you gross that up to adjust for the 35% corporate tax rate, you get roughly 9.2% pre-tax). But let's be generous and round that number up to a 10% pre-tax margin. Now you're talking about net profits of $10 billion, not $100 billion, and Dr. Cragan's $35 billion subsidy suddenly becomes $3.5 billion.
But even that is wrong. Under current law, donations to churches probably wouldn't be income even absent tax exemption, since donations likely would be considered gifts under Section 102, which are excluded from the income of the recipient (Section 102 applies to all taxpayers, not just charities). So unless Dr. Cragun is suggesting that we should repeal Section 102, his actual subsidy number is now zero. And that also wipes out the $6.1 billion in estimated STATE income tax subsidy, because states almost always key off Federal tax law in calculating state taxable income (e.g., gifts would be excluded from state taxable income, as well).
So now we've whittled Dr. Cragun's subsidy number down to $30 billion. But that's still pretty large. What about the rest of it? Well, the largest chunk of what's left is his estimate of a $26 billion loss via property tax exemption. Here's how he explains his methodology:
The Hartford Seminary estimates that there are 335,000 congregations in the United States. Using forty-seven churches in Tampa from six different religions as our basis (Presbyterians, Mormons, Baptists, Methodists, Episcopalians, and Pentecostals), we estimated that the average value of a church in the United States today is about $1.7 million (land and building). Because property taxes are paid at the state level, we averaged the total number of churches across all fifty states, multiplied the estimated number of churches by the average value, and then calculated the lost state revenues. States subsidize religions to the tune of about $26.2 billion per year by not requiring religious institutions to pay property taxes for property worth about $600 billion.
If a student used this kind of analysis in a paper for my Tax-Exempt Organizations class, I'd give them a "C" at best. This isn't a serious attempt to value the property tax exemption for churches; a truly serious study would take a locality-by-locality analysis, using available property tax records and individual local property tax rates, which vary enormously. Such a study would be hard and vastly time-consuming, which is probably why no one (to my knowledge) has done it. And I don't know where Dr. Cragun gets the approximately 4.3% effective tax rate he is using here (he doesn't explain how he gets to $26.2 billion at all; I reverse-engineered his tax rate). In one truly serious academic study of the value of tax-exemption for non-church charities - see Joseph B. Cordes, Marie Grantz and Thomas Pollak, What is the Property-Tax Exemption Worth? in Property Tax Exemption for Charities, Evelyn Brody, ed. (Urban Institute Press 2002), the authors use between a 1.3 and 2.1% national rate based on data from the Minnesota Taxpayers Association (1999) and the National Bureau of Economic Research (2000). I doubt national property tax rates have doubled or tripled in 10 years; so even if I accepted Dr. Cragun's estimate of the total value of church-held property (which I don't; the truth is that we simply don't have a good such estimate because churches aren't required to report this number anywhere), using the Cordes, et. al. methodology yields a tax benefit of $7.8 - 12.6 billion, not $26 billion. What the real benefit of property tax exemption to churches, however, is simply unknown. Dr. Cragun's estimate may be low (as he suggests in his footnote 25) or it may be high. The point is that without better data, any number is pure speculation.
I have no argument with the basic proposition that churches get substantial tax benefits from property tax exemption and other tax breaks, but there are so many issues with the $71 billion number that I cannot take it seriously. Neither, in my view, should the press.
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.
Tuesday, November 27, 2012
The use of 501(c)(4) nonprofits to support political campaigns was well-documented over the past election cycle (see, for example, LHM's prior post here). Since 501(c)(4) organizations do not qualify for tax-deductible contributions under Section 170 (only "charitable" organizations - generally those exempt under 501(c)(3) plus government entities qualify), the issue with (c)(4)'s isn't about tax giveaways for contributions used for political purposes, but rather that the use of the (c)(4) format permits politically-engaged organizations to avoid the disclosure laws applicable to federally-defined political campaign organizations.
But as this article in the Los Angeles Times illustrates, some states have become far more agressive in requiring disclosure by nonprofit organizations engaged in political activity. The aggressive stance began with California's crackdown on Americans for Job Security which was "unmasked as the source of an $11-million donation to oppose Gov. Jerry Brown's tax increase measure and support another measure intended to curb the ability of unions to raise money for political activity." California state officials found that AJS had run its money through two other nonprofit organizations in order to hide its origin - an effort state officials called "campaign money laundering" (California officials apparently are still investigating AJS to find the original donors of the $11 million).
California was not alone, however. Prior to election day, a judge in daho upheld state efforts to require disclosure from a politically-involved nonprofit. Secretary of State Ben Ysursa sued a group called Education Voters of Idaho, which spent some $200,000 for ads backing three state ballot measures, to force disclosure of its donors. After the court ruled in favor of the state, "the organization revealed it had received money from New York Mayor Michael R. Bloomberg and Albertsons supermarket scion Joseph P. Scott, among others."
In Montana, the state supreme court upheld on state law grounds a law banning political expenditures by corporations in spite of Citizens' United, though the U.S. Supreme Court overruled that decision. Subsequently, the voters of Montana passed Initiative 166, directing the Montana delegation to seek a constitutional amendment overruling Citizens' United.
Since the Supreme Court has indicated its support for disclosure (as opposed to expenditure limitations) in these kinds of situations, perhaps other states will step in with disclosure laws that Congress appears to have little interest in. One can dream . . .
Monday, November 26, 2012
According to this story from Lancaster Online, last May the IRS denied tax-exempt status to two joint ventures run by Lancaster General Hospital in Lancaster, PA. One of the joint ventures was a 50-50 deal with a for-profit company to run a rehabilitation center; the other was a 50-50 deal with doctors to run an ambulatory surgery center. According to the story, the IRS denied exemption because the 50-50 arrangement did not give Lancaster General (a tax-exempt 501(c)(3) charity) sufficient control over the joint ventures to assure they were run in a charitable manner.
This result indicates that the IRS's "control" test for determining charitable status of joint venture operations between a charity and a for-profit enterprise is still alive and well. The control test first surfaced in the "whole hospital joint venture" ruling, Rev. Rul. 98-15, and then was relaxed somewhat in the "ancillary" joint venture ruling, Rev. Rul. 2004-51. In that latter ruling, which would seem to govern the kinds of transactions involving Lancaster General, the IRS approved a 50-50 ownership arrangement, where the charity (a university in this case) had absolute control over the way in which the substantive services (educational distance learning) were delivered - (e.g., approval of the curriculum, training materials and instructors). After Rev. Rul. 2004-51, the control test sort of disappeared from view as practitioners learned to draft deals around the requirements. But the Lancaster General story indicates that it is still very much alive and enforced by the IRS.
I've frankly never understood why the IRS presses a "control" requirement in the context of ancillary joint ventures. "Ancillary" joint ventures by their nature are simply business deals done by a charity. The question involved in these cases should ONLY be whether the deal is a fair one to the charity (to avoid issues of private inurement and private benefit); if so, then the joint venture interest should be treated like any other commercial activity: that is, subject to the unrelated business income tax if indeed the venture's business is "unrelated" (in many cases, I would suggest that joint ventures entered into by hospitals to expand health services in fact are "related," but that's another story). It is very odd to me that an exempt hospital or exempt university could open a BMW dealership with no ill effects on exemption other than having to pay the UBIT. And a direct investment in a business corporation via stock doesn't create any exemption issues at all, not even UBIT issues. But a business investment done as a joint venture suddenly causes us to break out in hives . . . In my opinion, very odd, and not well-justified by any underlying theory applicable to exempt status.