4 min read
President Obama’s most recent proposal of reduction of the limit on tax deductions for charitable giving for individuals with incomes about $200,000 and couples with incomes about $250,000 will not make it through Congress. However, as a Chronicle of Philanthropy update noted this week, it’s important to continue to discuss why this proposal is misguided so that it won’t return when the Congressional debt-reduction committee makes its recommendations in November.

Non-profit leaders understand that a reduced limit on tax deductions for charitable giving would crimp the giving of wealthy donors. While one might wish that wealthy donors might give just as much when the tax incentive was reduced, non-profit leaders recognize that this simply isn’t the case.

Why? Economists have a straightforward explanation of such behavior: people buy less of something when its price goes up. Economists call this the “price elasticity of demand,” which is a measure of how much demand for a good stretches as its price drops and how much amount demand for a good contracts as its price rises.

The price elasticity of demand for some goods is quite inelastic: for example, U.S. households hardly changed the amount of gasoline they purchased during recent price spikes because people still needed to drive to work and take their kids to school. They weren’t able (at least in the short-term) to change how much gasoline they purchased even though it meant they were spending much more of their budget on gasoline. On the other hand, some goods have higher price elasticity: for example, wine and soft drinks have a higher price elasticity because people are easily able to choose to drink beer rather than wine or water rather than a soft drink. In fact, it turns out that when the price of wine goes up, on average people will spend roughly as much money on wine as before, but that amount will buy fewer glasses of wine.

We don’t often think of charity as having a market price. However, we can easily understand that, in the absence of subsidies or surtaxes, giving one dollar to charity has a market price of exactly one dollar.

The significance of the tax deduction for charity is that it changes the price of a charitable donation. We still give a dollar up front—but we get some of that back at tax time, so giving one dollar actually costs less than one dollar. Charities rely on our understanding of this when they promote year-end donations that can be reported on our upcoming tax filings.

The price change depends on one’s marginal tax rate—which, under our progressive income tax code, rises with a person’s income. For the highest-income taxpayers, who pay the highest marginal tax rates, the value of the tax deduction is currently thirty-five percent; for these taxpayers, giving one dollar has a price, after the tax break, of only sixty-five cents.

President Obama’s recent proposal would have reduced the maximum value of the tax deduction from thirty-five to twenty-eight percent, thus raising the price of giving one dollar by about eleven percent from sixty-five cents to seventy-two cents for high-income earners.

When non-profit leaders anticipated that a reduced limit on tax deductions would reduce gifts from wealthy donors, they were worrying—in economists’ terms—about the price elasticity of charitable giving for wealthy donors. Is charitable giving more like gasoline or like wine? Does raising the price of giving one dollar from sixty-five cents to seventy-two cents reduce giving a little or a lot?

It turns out that economists have studied the price elasticity of charitable giving for wealthy donors (…is there any topic economists haven’t taken up?).

As economist Jon Bakija of Williams College described in a recent Chronicle of Philanthropy article, he and Bradley Heim of Indiana University studied the tax returns of 550,0000 high-income tax payers filed during the period 1979–2005 in order to understand better how high-income taxpayers react to changes in the price of giving.

Bakija and Heim begin by noting the importance of high-income taxpayers to charities: according to their calculations, thirty-six percent of all charitable gifts claimed tax-payers on 2004 tax returns were given by those earning over $200,000. The average amount of charitable donations claimed was $140,000 (in 2007 dollars).

Bakija and Heim then studied how these taxpayers changed their level of charitable giving in reaction to changes in the price of charitable giving brought about by changes in the federal and state tax codes. The found that charitable giving by high-income taxpayers is quite responsive to price—and charitable giving is most responsive to price for those at the very highest levels of income.

As Bakija notes in his Chronicle of Philanthropy piece, there is

a significant impact of tax incentives on charitable giving, with each 1-percent increase in the price of charity reducing giving by a bit more than 1 percent.

The net effect is that when the price of charity rises, high-income taxpayers spend about the same amount out-of-pocket for charity, but that amount supports fewer charities—just as people on average spend about the same amount on wine when wine prices rise but that amount purchases fewer glasses of wine.

Bakija and Heim illustrate their claims about the price elasticity of charity by noting that there was surge of charitable gifts in 1986 in anticipation of the reduction of the value of the charitable deduction contained in the 1986 Tax Reform Act. Once that Act went into effect and the lower value of the charitable deduction was in place, there were lower levels of charitable giving. Changes in the way New York, Ohio, and California treated charitable donations in their tax codes also changed the price of charitable gifts and influenced levels of charitable giving.

Reducing the value of the charitable deduction once again will further depress charitable giving—giving that sustains so many of America’s most vital civil, cultural, and educational institutions for all Americans.

Leave a Reply

Your email address will not be published. Required fields are marked *