Tax-Exempt Organizations: How could incentives for charitable giving be improved?
Under current law, taxpayers who itemize are allowed to deduct most of their charitable contributions and thus reduce their taxable income and their taxes. Nonitemizers 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.
- One proposal would expand the existing incentive in exchange for a floor on deductions. Incentives are more powerful for the marginal (next, or incremental) dollar of giving than for the first dollars. Consider a person who would give away $1,000 regardless of any 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 will have a greater effect than one for the first $100 or even $1,000, which will 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 be used to expand other incentives. For instance, nonitemizers who give significant amounts to charity might be allowed to deduct many of their charitable contributions (see below) in combination with a floor under contributions by all taxpayers. The revenue gains from such a floor could be significant: the congressional Joint Committee on Taxation estimated that allowing the deduction only of charitable contributions that exceed 2 percent of adjusted gross income (AGI) would increase federal revenue by nearly $100 billion over five years and about $250 billion over ten years. A much more modest floor would 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 might create compliance problems: the Internal Revenue Service cannot reasonably be expected to audit small donations. Also, simply extending the deduction to nonitemizers 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 $500 if they are joint filers ($250 for single filers), regardless of whether they itemize. This combination likely would increase charitable giving at little or no cost in tax revenue and would address concerns about administration and compliance. How much net giving would increase depends upon the sensitivity of giving to incentives (see table).
- Another option would be to raise the limit on deductions for charitable giving above the current 50 percent of AGI. This would significantly increase incentives at the margin for large givers. One could also make carryover provisions with respect to this 50 percent limit more generous. 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 IRA rollover provision. This recently enacted provision, which expired in 2007, allowed some taxpayers over age 70½ to donate up to $100,000 from Individual Retirement Accounts (IRAs) and Roth IRAs to charities without having to count the distributions as taxable income. Restoring this provision and making it permanent, while raising or eliminating the $100,000 annual limit on donations and lowering the age limit to 59½ (the age at which IRA owners may withdraw funds without penalty) could increase charitable giving.
- A final option would eliminate or reform the excise tax on foundation income. The current excise tax on foundations’ income from assets was intended to cover the costs to the IRS of overseeing the tax compliance of charitable organizations, but it has never done so. The tax rate is either 1 or 2 percent, depending on whether giving this year equals or exceeds the average of a few past years. Under these current rules, foundations that make more grants 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 a minimum, Congress could impose a single tax rate on all such income, to remove the current perverse incentive for foundations to limit current grants today to avoid a higher tax in the future.