John E. Tyler examines the use of the charitable deduction as “subsidy,” analyzing its implications for the nonprofit sector.
In the cult classic The Princess Bride, the swashbuckling Inigo Montoya takes issue with another character’s persistent declarations of certain events as “inconceivable.” “You keep using that word,” Inigo observes. “I do not think it means what you think it means.”
Lately I’ve begun to wonder whether Inigo’s observation similarly applies to ways in which the term “subsidy” is used these days—both in reference to the charitable deduction and, more importantly, to justify actions derived from it.
Just Giving: Why Philanthropy Is Failing Democracy and How It Can Do Better, the latest salvo from Stanford professor Rob Reich, teems with representative examples of “subsidy” used expansively, as well as some of the implications of doing so. Reich laments three things in particular: the ability of certain donors to itemize their charitable deductions, the higher rates that allow them to deduct more of their donations, and that funds that would otherwise be spent by government instead are spent by charities and foundations. Prof. Reich is far from alone in decrying this state of affairs, but as I read his book, the words of Inigo Montoya began to echo in my ears.
What’s at stake in using “subsidy” to describe the charitable deduction?
From a matter-of-fact financial point of view, the term seems innocuous enough. However, as the term has increasingly expanded beyond accounting treatment, it has accrued implications as some sort of amorphous unfairness that favors some and intentionally discriminates against others. It has come to imply that the State “underwrites” the charitable contributions that certain taxpayers make (and thus, by extension, the organizations that receive them). Going farther, some declare the charitable deduction “subsidy” both inequitable and unjust.
By that logic, this expansionist notion of “subsidy” is then used to justify State power to interject more extensive government and public intrusions into—even control over—the governance, decision-making, operations, personnel, strategies, tactics, and other affairs of charities and foundations.
It is the “subsidy” expanders who, for instance, have sought to force collection and disclosure of information about the race, gender, and sexual preferences of board members and leaders. They have demanded quotas and ratios on personnel and their preferred activities. They have sought nebulous notions of “accountability” and “transparency” without clearly indicating what they mean by either. They have likewise used talk of “subsidy” to justify either selectively prohibiting engagement in policy advocacy and education on their preferred stable of topics or completely prohibiting such engagement on all topics.
And while these expansionists are sometimes clear in the demands they justify through notions of “subsidy,” they are usually far less clear on how their demands should be implemented. Sometimes it seems they want changes in the law; that is, affirmatively changing conditions under which deductions can be claimed or organizations can be exempt – not necessarily because the underlying change is a good idea in its own right but because merely there is a “subsidy.”
More frequently, however, demands seemingly emerge not from any evaluation of legal conditions for deductibility or exempt status, but rather from inferences about the nature of “subsidy.” Thus expansionists seek to impose their demands after donations are made and organizations have become exempt—an approach notably bereft of the democratic processes that many expansionists claim to value so highly.
Clearly, much more than semantics is at stake in the expansive use of “subsidy.” And so we must consider: How, and why, has this expansion taken place? And does “subsidy” really mean what expansionists think it means?
The Problematic Basis for Expanding “Subsidy”
The case for expansion from “subsidy” relies on some combination of the following: (1) the alleged unfairness of itemized charitable deductions; (2) the higher deduction rates itemizers can claim; and (3) the idea that government forgoes money that other taxpayers must make up.
Each of these positions suffers from incompleteness and/or inconsistency, and as each point falls, so too does the expansive meaning of “subsidy,” conclusions drawn therefrom, and resulting demands.
1. Itemized Charitable Deductions
Expansionists criticize the itemized charitable deduction on grounds that it is unfair to allow those who itemize to claim a charitable deduction denied to taxpayers using the standard deduction. This amounts, they argue, to itemizers paying less in taxes than they should—getting a subsidy not enjoyed by those who use the standard deduction.
Put differently: the standard deduction is unfair to those who use it.
What this line of thinking omits is that the standard deduction is an effort to simplify tax filing—to ease and expedite the process for most filers, even (by the way) if their underlying expenditures do not equal the standard deduction amount. It is not an institutional bias unfairly thrust upon non-itemizers or a strategy to treat itemizers better. Quite the opposite: the standard deduction seeks to ease the burden for non-itemizers.
This argument for expanding “subsidy” thus rests on a fundamental distortion of the function, simplicity, and efficiency of the standard deduction.
2. Progressive Tax Rates
The second basis for expansion rests on the fact that itemizers can deduct more of their charitable donations from their income tax. Even among those who itemize, those who earn more can deduct even more of their donations than other itemizers. This is because tax and deduction rates are the same. They are, in other words, an artifact of our progressive tax system, yet are framed by expansionists as favoring the wealthy—as if the increasingly higher tax rates that require some filers to pay a larger proportion of their income as taxes actually favors those taxpayers and unjustly disadvantages those whose rates are lower.
Such a position seems counterintuitive, at best, and mischaracterizes our current progressive tax system. There may be reasons to modify the tax system as it operates today—some of which may even treat itemizers and non-itemizers the same (e.g., a single flat tax rate or universal charitable deduction) while others may make it more complicated. It does not follow, however, that the progressive system should be twisted into the category of “subsidy,” as expansionists too often assert.
3. “Citizens” Pay and Government “Underwrites”
The third argument for expansion combines the following notions: (i) the State forgoes tax revenues from itemizers, (ii) the revenues lost to government thereby are “subsidy,” and/or (iii) others must pay more to make up the shortfall.
In other words, government “underwrites” and citizens thus “pay” for charitable contributions, organizations, and activities.
Among other problems, these notions extend the argument too far, either eliminating all distinctions or creating false ones that crumble under any rational consideration. For starters, these same three notions apply equally to the standard deduction and those who claim it. Objecting on these grounds to the standard deduction is neither politically nor emotionally appealing, but applying the arguments only to the itemized charitable deduction is logically incoherent.
In point of fact, the above notions apply with no less vigor to every other deduction, credit, and legal means of reducing taxes. If this argument forms the basis for expansionism, then nothing protects taxpayers who legally reduce their taxes from government or public intrusion. Nor is it a far leap in expansionist logic to justify State intrusion in the affairs not just of taxpayers but (as with recipients of charitable donations) any enterprise that receives any payment from any taxpayer claiming any deduction or credit for any reason.
All-encompassing governmental intrusion is the natural consequence of the expansionist mindset.
A further inconsistency: expansionists infer power to intrude from situations in which there is little or no government involvement, yet not from those with substantial government involvement. Remember, when a charitable contribution is made and corresponding deduction claimed, the taxpayer controls the money and decision-making about whether to donate, to whom, how much, when, for what purposes, and so on. Juxtapose that with cases in which government controls funds and makes decisions, such as grants or contracts.
How is it that the State being disconnected from control and decision-making justifies greater intrusion? This is by no means an appeal for increased intrusion in direct contexts. Instead, it serves as a warning: If expansionist demands apply when government lacks control and causation, imagine the reach and intrusions that could happen when government actually possesses control and causation.
Thus, expansionist arguments go too far, are inconsistently applied, and cannot support the conclusions drawn or actions sought because of them.
I Do Not Think “Subsidy” Means What You Think It Means
Our tax system is far from perfect, and I do not seek to defend it here. We must, however, recognize how that system is contorted, mischaracterized, and misused for dubious ends by the expansionist crowd.
The standard deduction aims to simplify filing to the advantage of those who do not itemize. Progressively higher tax rates on itemizers are not efforts to discriminate against those who earn less. Selectively appealing to basically indistinguishable tax policies that permit reductions in taxes owed proves too much and goes too far.
In other words, expansionist invocations of expanded, distorted, and contorted notions of “subsidy” do not make the word mean what they think it means. That should be, well, inconceivable.
John Tyler is General Counsel, Secretary, and Chief Ethics Officer for the Ewing Marion Kauffman Foundation. He also is a lecturer at Columbia University. The views stated here are his own and should not be attributed to either organization.
1 thought on “Charitable deduction as “subsidy”: does it really mean what some think it means?”
Important points. A vibrant charitable sector should mean government has less to do, meaning the money “lost” to the charitable giving deduction is really gained by reduced government spending.