Debating the charitable deduction


It would be hard to find anyone more qualified than Martin Feldstein to predict the effects of President Obama’s proposal to limit the tax deductibility of charitable contributions:

A high-income person paying taxes at a 35 percent marginal rate lowers his tax bill by 35 cents for every dollar that he contributes to a charitable organization. The net cost to the individual is 65 cents for every dollar received by the charity. A substantial body of economic research shows that, on average, each 10 percent reduction in the cost of giving raises the amount that a person gives by about 10 percent. So, the 35 percent reduction implied by current deductibility rules raises the amount of charitable giving by about 35 percent.

The administration’s plan would limit the amount that high-income individuals could deduct to 28 percent of their gifts, down from 35 percent, even though their incomes would still be taxed at a higher marginal rate. This raises the cost per dollar of giving from 65 cents to 72 cents, an increase of 10.8 percent that can be expected to reduce the total giving of these donors by about 10 percent.

President Obama’s proposal to limit the tax deductibility of charitable contributions would effectively transfer more than $7 billion a year from the nation’s charitable institutions to the federal government. But the high-income taxpayers affected by the rule change are likely to cut their charitable giving by as much as the increase in their tax bills, which would, ironically, leave their remaining income and personal consumption unchanged.

In effect, the change would be a tax on the charities, reducing their receipts by a dollar for every dollar of extra revenue the government collects. It is hard to imagine a rationale for taxing schools, hospitals, medical research budgets and arts organizations in this way. I suspect that the administration officials who drafted this proposal did not understand that it would have this perverse effect.

Read it all in the Washington Post.

In his prime time news conference last night Obama said,

Now, if it’s really a charitable contribution, I’m assuming that that shouldn’t be the determining factor as to whether you’re giving that $100 to the homeless shelter down the street.

And so this provision would affect about 1 percent of the American people. They would still get deductions. It’s just that they wouldn’t be able to write off 39 percent.

In that sense, what it would do is it would equalize. When I give $100, I’d get the same amount of deduction as when some, a bus driver who’s making $50,000 a year, or $40,000 a year, gives that same $100. Right now, he gets 28 percent, he gets to write off 28 percent. I get to write off 39 percent. I don’t think that’s fair.

So I think this was a good idea. I think it is a realistic way for us to raise some revenue from people who’ve benefited enormously over the last several years.

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The Center on Budget and Policy Priorities believes that capping the deduction for high income households would only decrease charitable giving by 1%.

(Disclosure: I'm a health policy intern there.)

The Urban-Brookings Tax Policy Center (both are highly respected think tanks) stated that only about 1% of households would be affected, consistent with the President's remarks.

the CBPP analyst I cited above used the same elasticity as Feldstein (i.e. a 10% increase in the cost of charitable contributions decreases contributions by 10%).

however, that only 62% of charitable gifts are itemized deductions (i.e., the other 38% are people giving less than the standard deduction). only about 12% of these deductions are given by people in the top 2 tax brackets. Feldstein didn't account for this.

In addition, we need to ask ourselves if it's fair for taxpayers to subsidize, say, 35% of every charitable dollar that people earning over $250,000 give to charity. last, while medical research and hospitals will be affected by the proposal, the charitable deduction cap was attached to the healthcare reform section of the budget. in other words, the money is going back into healthcare.

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