It is now obvious to most Americans that the nation faces unprecedented economic challenges as the gap continues to grow between the amount federal and state governments spend and the amount they collect in taxes.
With growing political consensus on the need to reduce the deficit, it is no longer a question of “if” the country will overhaul how it approaches taxing and spending; it is only a question of when and how we decide to put our nation’s fiscal house in order.
And that process is now raising a big question for every nonprofit in America—whether donors will be allowed the same tax benefits for charitable gifts in the future as they are today.
Members of Congress and the White House have floated several proposals for ways to change how our federal tax system treats charitable gifts, mortgage interest, and other itemized deductions.
The president’s latest budget proposal would, for example, raise money for the federal Treasury by imposing new taxes on the amount the wealthy give to charity. While no one is sure what “wealthy” might ultimately mean under this plan, the president has previously suggested that he means people who make $250,000 or more per year. That definition covers more people than you might think—including the average police captain married to a nursing supervisor in New York City.
Changing the tax treatment of charitable gifts in ways that make it more costly to give those gifts will undoubtedly cause many higher-income Americans to reconsider the amount of their gifts.
At no other time in history could this be more harmful to the nation’s nonprofits, especially given the extraordinary drop in donations caused by the recent economic downturn—and the large share of contributions provided by Americans who make $250,000 or more.
Today a donor in the highest tax bracket who makes a $100,000 gift to charity is excused from paying federal income tax of up to 35 percent on that sum. (Editor's note: The previous sentence has been corrected from an earlier version to fix a typographical error.)
Under the proposed plan, however, a new tax of $7,000 would be due because people in the upper-income brackets could only deduct charitable gifts at the 28-percent tax rate.
If the 39.6-percent tax bracket is restored, as the president has suggested, the out-of-pocket cost of making a gift would rise even more. The only way to keep the cash outlay for charitable gifts the same under these circumstances is to give less.
The deductibility of charitable gifts regardless of one’s tax rate—rich or poor—has been a time-tested component of the tax code that has survived innumerable challenges for nearly a century. Some support the deduction as a way to encourage charitable giving, while others believe that amounts voluntarily given to charity should be treated differently from income that people spend, save, or otherwise use for their own benefit—and should not be taxed like the income devoted to personal use.
Limits already exist on the amount of charitable gifts a taxpayer can deduct. For example, people can deduct no more than 50 percent of their adjusted gross income for their charitable gifts (or 30 percent in the case of appreciated securities and some other noncash assets). The theory behind these limits is that no one should completely opt out of taxes by giving all of his or her income to charity. According to the Internal Revenue Service, some 439,000 generous Americans encountered these limits on charitable deductions in 2008.
Central to understanding this debate is one simple truth: Regardless of tax rates, it always costs money to make a charitable gift. That is why the tax deduction for charitable gifts is by no means the primary motivation for most donors when deciding to make donations. That being said, limits on charitable deductions can increase the cost of gifts and can cause donors to change the amount and timing of their gifts.
What experienced fund raiser has not heard a donor say, “My accountant has advised me not to give any more this year”? Why? Because to give more would mean paying taxes on the additional money they give to charity.
If the administration’s proposals are adopted, the impact of the tax increase aimed at charitable gifts would fall on donors who are already paying the highest tax rates and stand to face the largest tax increases on the income they otherwise spend for their own benefit. Why should those who voluntarily give of their wealth to benefit others be singled out for a tax increase as a reward for their generosity in the same way as those who deduct the interest on jumbo mortgages?
To be sure, no one really believes the administration relishes that thought or considers charitable giving to be equivalent to tobacco use or other undesirable behavior that most believe the tax code should discourage. Nevertheless, raising the price on charitable giving for the “wealthy” will be costly collateral damage in the budget- deficit wars.
There is a problem with proposals that seek to treat all itemized deductions the same way. The mortgage deduction, for example, benefits just one person—the borrower. But the charitable deduction in no way enriches the donor, and it benefits society as a whole. Too much mortgage interest being freely deductible arguably may have helped create the housing bubble and contributed in part to our nation’s precarious economic situation. Excessive charitable giving almost certainly did not.
Unfortunately, alarming new evidence now indicates the economic tumult of the past few years impacted charitable giving more than many experts previously thought.
According to final tallies by the IRS, the amount Americans gave to charity and deducted from their tax returns declined by nearly 11 percent in 2008 alone. And recently released IRS estimates suggest an additional decline of nearly 10 percent for 2009. That is a total of almost 20 percent in recession-related declines. (See article.) America’s nonprofits have not faced similar drops in giving since the Great Depression.
The deeper one goes into the IRS data, the starker the problem becomes with the proposal to tax charitable gifts by those deemed to be wealthy. For example, those with incomes of $200,000 or more (who are responsible for nearly half of all charitable deductions) reduced their giving by 20 percent in 2008 alone.
That is in keeping with the fact that incomes reported by people at this income level dropped by 13 percent from 2007 to 2008, more than four times the 3-percent drop reported by people with incomes below that level.
Although statistics for giving by income for 2009 are not yet available, the estimated 10-percent overall reduction would suggest that we may see a similar picture for that year. No figures are yet available for 2010.
If the proposed new tax on giving resulted in another 20-percent drop in giving by those with incomes over $200,000, that would mean an additional loss of gifts from individuals totaling more than all that American corporations donated in any recent year, and about one-third of the total given to all human-service groups.
While giving by Americans is indeed resilient, we have discovered the hard way that it is by no means immune to the vicissitudes of economic fate.
The losses wealthy people suffered in the recession have already reduced the amount they can afford to give to charity. Is now the time to discover how much greater those reductions might be if a new and unprecedented tax is imposed on those gifts? Can our nation’s educational, religious, health-care, arts, and social-service organizations afford to find out? Will Congress stand ready to replace what may have been lost?