Search This Blog

Saturday, August 7, 2010

Chartiable contribution deduction - improving tax system equity

The federal income tax is loaded with special deductions, credits and exclusions that typically violate several principles of good tax policy. For example, allowing a mortgage interest deduction on debt up to $1.1 million - far beyond the median home price, and allowing a deduction for interest on a second home as well as on up to $100,000 of home equity borrowing, provide significant tax reductions to mostly higher income individuals. This rule violates the equity principle. For example, if two individuals each have $90,000 of income and one owns a home and the other does not, the homeowner can borrow against his home equity and deduct it, but the other individual borrowing on a credit card cannot deduct that interest. Also, since these benefits are deductions, they are worth more to those in higher brackets than to those in lower brackets.

The mortgage interest example also points out where government spending can be reduced to help balance the budget. Stop subsidizing interest on expensive homes, vacation homes and home equity loans. But that is another topic - back to equity and charitable contributions.

Another area where greater equity and fairness can be achieved is with charitable contributions. Like the home mortgage deduction, these contributions are worth more for higher income individuals than for those in a lower bracket. That means a greater subsidy to the higher income individual who arguably needs is less. For example, two people donate $100 to charity. Jane is in the 35% bracket and Tom is in the 15% tax bracket. Jane saves $35 on her taxes from the contribution (so is out of pocket $65) while Tom only saves $15 (he is out of pocket $85 to make the same contribution). A tax credit would be better in providing the same subsidy to all donors.

I see at the TaxProf blog (8/6/10) there is an upcoming law review article that looks at the positive and negative externalities of charitable contributions and questions why all get the same tax treatment. The article by Shannon Weeks McCormack entitled "Taking the Good With the Bad: Recognizing the Negative Externalities Created By Charities and Their Implications for the Charitable Deduction" will be in the Arizona Law Review (see SSRN abstract).

I also recall reading in a New America Foundation book, I believe it was The Radical Center by Ted Halstead and Michael Lind, that the charitable contribution deduction should be reformed so that a deduction to the opera or symphony is not worth as much as a donation to a homeless shelter. I think these are good points, along with why donations to some groups, such as some well-endowed universities and foundations are worth as much as for struggling organizations trying to help the needy. Has someone truly made a charitable contribution if the donee is just going to put the funds in their big bank account?

Hopefully reform of the income tax will happen soon so it can better meet the principles of good tax policy, particularly simplicity, equity, neutrality and minimum tax gap. Part of the process will undoubtedly require reduction or elimination of some tax breaks as a way to lower rates (or keep them from rising) and make the system simpler. There are possible improvements to most tax breaks, including charitable contributions.

What do you think?


Brian said...

Professor Nellen:

I don't think distinguishing between the worthiness of charitable organizations is a simple as you present it here? On the surface, I can understand why one would be tempted to say that a contribution to a homeless shelter is more beneficial to society than a contribution to the opera. It seems that people think only "rich" people go to the opera, so donations to such an organization are not as beneficial to society.

However, I disagree with that assessment. I worked in the development department at the Tennessee Performing Arts Center in Tennessee for several years. we fought that same perception regarding the value of a donation to the performing arts center. However, what people did not realize was that the money we raised through donations and foundation grants was earmarked for the center's education programs. We had an excellent staff administering several wonderful education programs.

One of the programs was called Wolf Trap. Through Wolf Trap, funds were provided to allow performing artists to go into Head Start classrooms to do arts instruction. As I'm sure you know, Head Start serves poor, disadvantaged children and this program gave those same children exposure to performing arts they would otherwise never have.

Another program we had was called Humanities Outreach Tennessee. Through this program, school students throughout Middle Tennessee were able to come to our center to see various opera, ballet, symphony performances and plays. Up to 50,000 kids would come through our theaters in a school year. This program also trained teachers to integrate arts instruction into their classrooms and help prepare the students for the performances they viewed. Many of these kids also came from disadvantaged areas and had exposure to the arts they might not have received otherwise.

Many of the performing arts centers around the country have similar programs. While some of the centers do raise money for capital improvements to theaters and other purposes, as my example shows, it's not so easy to distinguish what types of donations are more beneficial to society than others.

Professor Nellen said...

Brian - thanks for the post - great observations. I agree that the arts serve more than high income individuals and funds are needed to ensure that they get to everyone. I think though that a basic needs hierarchy can be considered (food and shelter having a high priority). Also, something should be done to better ensure that "donations" are not just sitting in big bank accounts. Senator Grassley pushed this issue with universities with big endowments - a reminder that the funds need to get used for charitable purposes.

Thanks again for the insights.