How could we improve incentives for charitable giving?
Proposals include establishing a floor on deductions in exchange for more effective incentives, offering a nonitemizer charitable deduction, strengthening the IRA charitable rollover, revising the excise tax on foundations, raising the limit on deductions, and allowing people to claim charitable deductions for the previous year up to the time of filing tax returns, as in the case of deposits to individual retirement accounts.
Under current law, taxpayers who itemize are allowed to deduct most of their charitable contributions, thereby reducing their tax liability. Taxpayers who do not itemize have no comparable tax incentive to donate to charities. In addition, current limitations on deductions reduce existing incentives to donate. Various proposals would restructure tax incentives to encourage more giving.
Floor on deductions
One proposal would expand the existing incentive in exchange for a floor on deductions. This makes some sense because incentives are more powerful for the incremental dollar of giving than for the first dollar.
Consider a person who would give away $1,000 with no tax incentive but who would give $1,100 if offered a tax incentive to do so. Clearly, an incentive applied to the last $100 of that person’s giving would have a greater effect than one for the first $100 or even the first $1,000, which would be given anyway. It therefore may make sense to allow deductions only above a floor. The revenue gains from disallowing deductions below the floor could then be used to expand other incentives. For instance, nonitemizers who give significant amounts to charity might be allowed to deduct some of their charitable contributions.
The revenue gains from a floor could be significant. The Congressional Budget Office estimated that only allowing deductions that exceed 2 percent of adjusted gross income (AGI) would increase federal revenue by more than $15 billion a year. A more modest floor would still provide substantial revenues that could be used to increase the incentive to give.
At present, taxpayers who take the standard deduction cannot claim a deduction for charitable giving. Extending the deduction to these nonitemizers would likely increase charitable contributions, but by itself might create compliance problems: the Internal Revenue Service cannot reasonably be expected to audit small donations. Also, offering a deduction to nonitemizers separate from the deduction for itemizers would increase the complexity of filing in an already complicated income tax system. Many taxpayers would have to calculate taxes two different ways to decide whether they should take their charitable deductions as an itemizer or as a nonitemizer.
However, if a deduction for nonitemizers were combined with a reasonable floor applied to all taxpayers, much or all of the revenue loss due to noncompliance would be eliminated, as would the added complexity. (Small, merely symbolic floors would not achieve this objective.) For instance, taxpayers might be allowed to claim charitable deductions greater than 1.8 percent of AGI, regardless of whether they itemize. This combination would likely have little impact on charitable giving but would raise as much as $10 billion in tax revenue, and would address concerns about administration and compliance. How much net giving would change depends upon the sensitivity of giving to incentives (figure 1).
Raising the limit on the deduction
Another option would be to raise the limit on deductions above the current 50 percent of AGI. This would significantly increase incentives at the margin for large givers. One could also make the carryover provisions more generous with respect to the 50 percent limit. Taxpayers may currently carry over excess contributions to future returns, but only for five years, and any new contributions must be deducted before any carryover.
Yet another proposal would expand and make permanent the charitable individual retirement account (IRA) rollover provision. This provision allows some taxpayers over age 70 years and 6 months to donate up to $100,000 from traditional IRAs to charity without having to count the distributions as taxable income and then, if eligible, take an itemizer deduction. Making this provision permanent, while raising or eliminating the $100,000 annual limit on donations and lowering the age limit to 59 years and 6 months (the age at which IRA owners may withdraw funds without penalty) could increase charitable giving.
Foundation excise tax
Another option would eliminate or reform the excise tax on foundation income. The current excise tax on income from foundation assets was initially intended to cover the IRS’s costs of overseeing the tax compliance of charitable organizations, but the monies were not appropriated. The tax rate is either 1 or 2 percent, depending on whether the year’s giving equals or exceeds the average of the last few years. Under these current rules, foundations that give at above-average rates today face a penalty of being more likely to face the 2 percent rate in future years. Lowering or eliminating the tax would increase the net assets available to give to charitable beneficiaries.
Congress could also increase the minimum payouts that a foundation must make by the amount of the tax reduction. At very least, Congress could impose a single tax rate on all such income; this would eliminate the current perverse incentive for foundations to limit current grants today in order to avoid a higher tax in the future.
Allowing Charitable Deductions up to April 15 or Time of Filing Tax Returns
Another proposal that passed the House of Representatives, sometimes called the April 15 option, would allow individuals to take charitable deductions up to April 15 or the time of filing tax returns. The proposal costs the government almost nothing if there are no increases in giving because it doesn’t really change the subsidy value of giving another dollar to charity. In terms of bang per buck, or increased giving per dollar of revenue cost, it ranks very high. Economic and marketing evidence supports the notion that people would give more because they would be more aware of the size of the incentive, tax return preparers and tax software developers would help advertise the opportunity at hand, and people would receive immediate rather than delayed support for their contributions.
Urban-Brookings Tax Policy Center. “Microsimulation Model, version 0411-2.”
Bakija, Jon, Joseph Cordes, and Katherine Toran. 2013. “The Charitable Deduction: Economics vs. Politics.” Washington, DC: Urban Institute.
Colinvaux, Roger. 2013. “Rationale and Changing the Charitable Deduction.” Tax Notes 138 (1453).
Colinvaux, Roger, Brian Galle, and C. Eugene Steuerle. 2012. “Evaluating the Charitable Deduction and Proposed Reforms.” Washington, DC: Urban Institute.
Congressional Budget Office. 2011. “Options for Changing the Tax Treatment of Charitable Giving.” Washington, DC: Congressional Budget Office.
Steuerle, C. Eugene. 2013. “Tax Reform and Charitable Contributions.” Testimony before the US House Committee on Ways and Means, February.