With tax law changes swirling around us every day, nonprofit executives like me lie awake nights wondering how these changes will affect the charitable giving on which we depend. Will the recent tax increases hurt us, as so many journalists and commentators have warned? And what will be the effect of the changes President Obama still plans to seek?
We don’t have to speculate. We have data about which fears are legitimate and which ones are not. And some may find the truth surprising.
Predictably, the deal that emerged over the holidays featured President Obama’s promised tax-rate comeuppance for America’s dreaded “millionaires and billionaires,” raising the top marginal income-tax rate from 35 percent to 39.6 percent It also reintroduced an old law (the so-called “Pease” provision) that slightly lowers the value of all deductions.
In these policies, some observers predict a hard blow to charitable giving. In the long run, it is true that the best way to ensure healthy giving is a stable and growing economy in which Americans have an incentive to earn more money—and that will happen only if they can keep what they earn. In the short run, however, the tax changes just adopted will actually raise giving slightly.
Alan Viard, a tax economist at my organization—the American Enterprise Institute—has shown that the Pease provision will have virtually no impact in encouraging or deterring giving. And for most families facing a tax rise, the incentive to give is now actually a little bit more enticing than it was last year.
When the marginal tax rate—the rate paid on the last dollar of income—rises, it affects giving in two ways. First, the tax increase lowers disposable income, depressing giving.
Second, however, it lowers the “price of giving”—the amount of a contribution actually paid by the donor—which encourages people to give more. For example, if my marginal tax rate rises from 35 percent to 39.6 percent, that means I have a higher deduction and my taxable income falls when I make a gift. The price I pay for every $100 donated falls from $65 to $60.40.
Using data on the charitable giving of 8,690 families compiled by the University of Michigan and the Indiana University Center on Philanthropy, we can estimate the total impact from the recent tax changes.
Imagine a couple who together earn $1-million from their jobs and give $20,000 to charity. In 2013, they will pay $25,300 in new taxes due to the rate increase (39.6 percent instead of 35 percent on income above $450,000). Their disposable income falls by about 2.5 percent, while the price of giving has fallen by about 7 percent.
A statistical analysis of giving behavior shows that the income decrease will lower the amount they give by about 1.1 percent. Meanwhile, the change in the price of giving will increase their giving by about 4.6 percent. The upshot of all this: They will probably increase their giving by about 3.5 percent, or $700.
So should nonprofit leaders send Mr. Obama a thank-you note? I would advise holding off on that.
President Obama has made clear that the tax increases called for in the New Year’s Day deal were just his first bite at the apple. The night he signed the agreement, he called for “further reforms to our tax code so that the wealthiest corporations and individuals can’t take advantage of loopholes and deductions that aren’t available to most Americans.”
If Republicans hope to curb America’s ruinous spending and overhaul Social Security, Medicare, and other entitlement programs in any way, they can expect Mr. Obama to demand new laws limiting deductions, including for charitable gifts. The administration has said in the past that it would like the ceiling to be 28 percent, meaning that anyone with a marginal tax rate higher than this would see an increase in the price of giving.
Nonprofits that depend on charitable gifts would not emerge unscathed. Consider the possible effect of the 28-percent deduction cap. Families with a marginal tax rate higher than 28 percent are responsible for more than 20 percent of all charitable donations, according to figures for 2009.A deduction cap of 28 percent will, all else being equal, lower total giving by more than $2-billion. Perhaps those sympathetic to the administration might say this is a small price to pay for progress toward the goal of a larger welfare state.
The price goes up, however, depending on the type of nonprofit. Secular organizations in general would see losses higher than religious groups, and those that depend on higher-income donors would be hurt most of all. For instance, a university that relies heavily on upper-income alumni could expect a hit to contributions of 2 percent. An art museum with a typical donor in the top 1 percent of earners would lose more than 6 percent of its contributions.
What’s even more worrisome, though, is that economists who study giving believe that these tax effects are muted due to economic uncertainty. So as the economy improves, charities would be hit much harder by the tax-deduction cap. That means the art museum could expect to see donations drop by almost 10 percent due to the 28-percent deduction cap.
For some nonprofits still battered by five years of a downturn, that kind of loss would necessitate layoffs of staff members and reductions in programs.
How would they make up the losses? Predictably, some would come begging to government officials for a handout. The successful supplicants would come to depend more on government money and less on private donations. The state would insinuate itself into more of our charitable activities. And government spending would—as it always seems to—increase.
Arthur Brooks is president of the American Enterprise Institute and author of more than 50 books and academic studies on charitable giving.