News and analysis
December 01, 2010

Key Panel Seeks to Revamp Charity Tax Breaks

Alex Brandon/AP Images

Erskine Bowles, a former White House chief of staff, and Alan Simpson, a former Senator, are co-chairmen of the National Commission on Fiscal Responsibility and Reform.

The chairmen of President Obama's deficit commission—in their final plan for improving the nation's fiscal health—today offered a proposal to eliminate the charitable deduction and replace it with a 12-percent tax credit.

However, only people who had donated a certain percentage of their income would  be eligible.

The new plan, which is expected to be voted on by the full commission on Friday, proposed changing the charitable tax break as part of a broader effort to simplify the tax code, reduce the deficit, and lower individual and corporate income-tax rates.

The plan would end all itemized deductions and create three new individual tax brackets, from 12 percent to 28 percent.

The 12-percent credit for charitable gifts would be available only for amounts beyond 2 percent of the taxpayer's adjusted gross income.

It would be "nonrefundable," meaning only people who owed income tax could claim it. (Several liberal groups this week proposed a refundable tax credit that people could get even if they owed no taxes.)

By applying the same percentage across the board, the new credit treats taxpayers more equally than the current system, which favors high earners because they are more likely to itemize and earn a bigger tax break than people in lower tax brackets.

Small Donors

However, imposing the 2-percent minimum would disqualify many small donors.

"This is very little incentive for charitable giving," said Laura Kalick, a nonprofit tax lawyer in Bethesda, Md., adding that a 12-percent credit is not a huge tax break.

She said some charities would also be hit with a "double whammy" because the deficit plan would also end the tax exemption for interest on new state and municipal bonds—a mechanism that some organizations like hospitals and universities use to raise money for building projects. That could make the bonds less interesting to investors.

Rosanne Altshuler, a professor of economics and tax expert at Rutgers University, noted that today donors in the top tax bracket can get a 35-percent deduction for their gifts, so the new proposals would raise the cost of giving for them. At the same time, she added, "We may see more giving from people who were previously non-itemizers."

A fair number of taxpayers are likely to meet the 2-percent threshold, she added. She pointed to Treasury Department data showing that more than half of all taxpayers who itemized in 2002 donated to charity more than 2 percent of their adjusted gross income.

Range of Ideas

Today's proposal is the latest in a series of recent plans that seek to restructure the tax code and lower the federal deficit. All of the plans include measures that would eliminate or reduce the federal tax deduction for taxpayers who make contributions to nonprofits.

The new proposal differs from several options that the chairmen—Erskine Bowles, a former Democratic White House chief of staff, and Alan Simpson, a former Republican senator—proposed in a draft report last week.

Those included lowering income-tax rates and completely ending the charitable tax break unless it could be paid for by raising those rates, or leaving it as a deduction but only for giving above 2 percent of gross adjusted income.

Their final report—which warns that "everything must be on the table" because "America cannot be great if we go broke"—said its specific recommendations on overhauling the tax code are meant to be "illustrative" and that there could be other ways to achieve the same goals. Those goals include maintaining some kind of incentive for charitable giving, it said.

If 14 of the 18 members of the panel, formally known as the National Commission on Fiscal Responsibility and Reform, endorse the plan on Friday, it will go to Congress for a vote. Given that a majority of its members are members of Congress and that many of the proposals affect politically sensitive issues like Social Security and the mortgage deduction, many observers are pessimistic that will happen.