New Research Supports Maintaining the Charitable Deduction

The income-tax charitable deduction continues under fire, even though three new research studies support what Pentera has been saying for years: the deduction definitely works as an incentive to stimulate charitable contributions, particularly among the wealthy.

For the seventh year in a row, President Barack Obama has proposed capping the charitable deduction at 28 percent rather than letting it correspond to the taxpayer’s income-tax bracket. Another proposal in Congress would disallow the deduction unless a taxpayer’s contributions exceed 2 percent of adjusted gross income.

The three new studies, all by economists, were released last fall. While they differ on how dramatically charities are impacted by changes in tax law, they agree that the deduction works as a charitable incentive: Nonprofits receive at least as much as the government would have gotten in taxes without the deduction. Officials and board members of nonprofits may want to use these studies when contacting Congressional representatives and asking them to oppose reductions in the deduction. Here is what the economists say:

• “Tax incentives for charitable donations in the United States succeed in causing donations to increase,” wrote Jon Bakija, Williams College economics professor, in a 2013 study published last September in the academic journal Social Research. “This strengthens the case for the tax subsidies for donations.” His study can be found here: Bakija study
• “Those who give the most tend to be the most tax-sensitive,” wrote University of Michigan economics professor Nicolas J. Duquette in a December 2013 research paper. “If the charitable contribution for upper-income households were to be curtailed by a future tax reform, it is entirely possible that charitable giving would fall.” His study can be found here: Duquette study
• “A contemplated deduction cap would have a relatively large negative impact on giving,” wrote Arthur C. Brooks, an economist who is president of the American Enterprise Institute and formerly a professor at Syracuse University. His study can be found here: Brooks study

These studies and others vary widely on how much changes in tax laws affect charitable giving, but all agree that the deduction works because it lowers the “cost” of philanthropy. As tax rates go up, the corresponding deduction goes up and thus charitable giving goes up—even though that may seem counterintuitive because the donor is paying higher taxes.

For instance, the new highest tax bracket of 39.6 percent means that a high-income taxpayer typically saves $396 in taxes on a $1,000 donation, when with the previous tax brackets the highest possible savings was $350. Thus, the new highest tax bracket reduces the cost of giving a thousand dollars to $604 from $650—and taxpayers generally will increase donations and give the savings to the charity, according to the economists.

A reduction in the charitable deduction to 28 percent means that the highest-income taxpayers would have a cost of $720 to make a $1,000 donation—a significant cost increase from $604 that would likely cause a corresponding reduction in charitable donations. Brooks estimated that the 28 percent proposal could cost charities more than $9 billion in the first year.

While the exact impacts of such proposals are the subject of hot debate, experts agree that charities get at least as much as the government gives up in taxes due to the charitable deduction. Nonprofits thus get to provide the services that otherwise would become government responsibility. As Pentera has been saying for years: The charitable deduction works, and we should continue to let it do so.