How to Undertake Reform of the Charitable Deduction

Among its many changes, the 2017 Tax Cuts and Jobs Act substantially increased the share of federal income taxpayers taking the standard deduction, leaving fewer tax filers claiming the tax deduction for charitable contributions. Ever since, some lawmakers have sought ways to incentivize giving for those who don’t itemize.

It’s unlikely that Congress or the public will long tolerate an incentive now narrowly targeted to only to about one tenth of all taxpayers, usually those with incomes well above average. In my recent testimony before the Senate Finance Committee, I offered a number of options for how to improve incentives to give. But my primary suggestion was for members of Congress to compare options under a cost-effectiveness rubric. That means putting gains for charitable beneficiaries—not taxpayers or even the charities themselves—as the major objective. The cost to taxpayers, in turn, equals their tax reduction less their increase in charitable contributions.

Imagine Congress would tentatively agree to consider some level of total annual subsidies for charitable giving, for instance, increasing current level from about $50 billion to the $70 billion level that would exist in absence of recent cutbacks in the incentive. Then it would consider alternative ways to achieve this goal.

Along with revenue estimates and distributions of tax reductions among taxpayers in different income categories, the Joint Committee on Taxation ideally would show the net amount of giving going to charitable beneficiaries under different proposed policies. That way, lawmakers can better select the most cost-effective option. Similar comparison could be made at other cost levels, so that Congress could separate the decision on how much to spend from how well to spend it.

Unfortunately, Congress and the Executive Branch typically fail to engage these types of comparisons. Such comparisons are especially absent when Congress is debating bills designed to give away money, whether in the form of tax cuts or spending increases. Lobbyists and members seldom want to ask who pays or whether the same amount of money can be spent in a more cost-effective way.

Many of the options for creating a charitable deduction for those who don’t itemize are not very cost effective. One would provide a deduction for all taxpayers capped at one-third the value of the standard deduction; it would cost $21 billion and generate only about $4 billion in charitable giving under standard assumptions about the responsiveness of taxpayers to incentives. An unrestricted universal deduction for all taxpayers would incentivize $9 billion in additional charitable giving, but at a cost about $27 billion.

Even if taxpayer were much more responsive, these approaches still fail relative to alternatives because they use a huge amount of resources to subsidize the first dollars of giving—the giving that would take place without an incentive. They also provide substantial tax cuts to so-called “switchers”—those higher-income taxpayers who currently itemize but switch to the standard deduction and take a charitable deduction as well.

Consider a married couple in 2021 who pays $10,000 in state and local taxes, contributes $20,000 to charities, and declares itemized deductions of $30,000. Now suppose that an unlimited charitable deduction had been allowed. The couple could then have taken a standard deduction of $25,100 and still claim a charitable deduction of $20,000, thereby getting an additional $15,100 in total deductions without receiving any new incentive and without giving any more.

Many proposals also ignore the inability of the IRS to enforce the current deduction, with its very limited audit rates and no computerized document matching to verify claims without an expensive audit.

Several approaches can make a more universal deduction more cost effective. Denying deductions for the first 1 or 2 percent of income would shift incentives more toward subsidizing additional giving rather than the giving that would take place anyway. A better system of reporting to IRS would provide revenues from improved compliance that could then be spent to enhance charitable incentives.

Engaging in a more rigorous, transparent analysis of the tradeoffs involved would help charities and lawmakers make decisions in the best interest of charitable beneficiaries. If the Joint Committee on Taxation produced an estimate that said that one bill would cost $10 billion and encourage $3 billion in charitable contributions, while another would cost $10 billion and raise $10 billion in charitable contributions, any group arguing for the first option would need to accept responsibility for advocating for $7 billion less in services and aid to charitable beneficiaries.

Comparisons like these are a simple but classic way to enact reforms that lead to better government at any size. The lack of such discussions more broadly reveals a major defect of our current legislative process for almost all fiscal issues.