A Better Charitable Act Is Cutting Tax Rates, Not Creating Another Tax Break

Do Americans need a tax incentive to be charitable? Economists have mixed opinions, but two senators believe so.

During the last Congress, Oklahoma Republican Sen. James Lankford and Delaware Democrat Sen. Chris Coons introduced the Charitable Act, which would allow taxpayers who take the standard deduction to still claim a deduction for their charitable gifts. The legislation received strong backing from dozens of nonprofit groups and is likely to be reintroduced this year. These and other advocates see the debate over extending the expiring 2017 Tax Cuts and Jobs Act (TCJA) as an opportunity to build support for creating an “above-the-line” deduction, a downward adjustment to taxable income available to anyone and everyone who files a return.

According to Lankford, “Most people don’t itemize their taxes, so there’s no incentive to be able to give to nonprofits through our tax code.” He believes that increasing the tax incentive to donate will help benevolent organizations and reduce dependency on government.

As well-intended as this legislation is, it is based on the mistaken belief that the charitable deduction has been broadly available to most taxpayers and thus must be restored. Lankford is correct that most people don’t itemize their taxes and don’t have a tax incentive to donate to charities. But that has been true since the charitable deduction was created more than a century ago.

Artifact of Another Era

The charitable deduction is an artifact of an era when tax rates on the rich were very high and has never been a deduction for the masses. It was established in the Revenue Act of 1917 out of concern that the high income-tax rates levied at the outset of World War I (when the top tax rate was 63%) would discourage charitable giving. Despite their concern, lawmakers limited deductions to 15% of taxable net income. There have been limitations on the deduction ever since.

Historically, a minority of taxpayers has claimed the deduction, even in years when the top income-tax rate was exceptionally high and the value of the deduction was at its most beneficial. For example, in 1954, when the top tax rate was 91%, only 23% of filers claimed the deduction. In 1979, when the top rate was 70%, just 26% of filers claimed the deduction.

Flash forward to 2017’s TCJA. When it was being debated, the top marginal tax rate was 39.6%; just 25% of taxpayers claimed the charitable deduction.

TCJA made the tax code much simpler for millions of taxpayers by nearly doubling the standard deduction, while cutting income tax rates across-the-board. As a result, the percentage of filers claiming the charitable deduction fell from 25% to 10% in 2018. Today, only 9% of filers claim the deduction. And nearly half (48%) of charitable deductions claimed in 2022 were by taxpayers earning more than $1 million.

Charitable-deduction advocates claim that the expanded standard deduction has led to a dramatic decrease in charitable giving. They cite a recent academic study estimating that taxpayers who shifted from itemizing their deductions to claim the standard deduction reduced their charitable giving in 2018 by $880 per taxpayer. The combined impact of this shift, according to the authors, amounted to $20 billion in fewer contributions in 2018, the year following TCJA.

If expanding the standard deduction had any impact on giving, it appears to be temporary. Internal Revenue Service (IRS) data do indicate that charitable contributions to nonprofits dipped slightly in 2018, in both nominal and inflation-adjusted terms. But the data also show that giving in 2019 topped pre-TCJA levels and continued to grow throughout the COVID years. By 2021, charitable contributions were at record levels in both nominal and real terms.

Incentives and Impact

History has shown that there is little relationship between the charitable deduction and giving. Instead, giving tends to rise when the economy is good and incomes are rising. There have been multiple tax-law changes during the past 40 years that have altered the value of the deduction, as well as the number of taxpayers claiming the charitable deduction, often from year to year. Despite these fluctuations, individual donations have nearly tripled in real terms since 1983, according to Giving USA, growing from $159 billion to $439 billion in 2021.

Lawmakers also must be mindful that tax incentives don’t always induce the kind of responses they intend. Sure, most people will claim a tax deduction if it is available—who wouldn’t take advantage of a half-off sale at Nieman Marcus? But there are many examples of tax breaks that have not encouraged the behavior lawmakers intended.

The mortgage-interest deduction is a good example. Research has found that it does not induce people to purchase homes, nor does it make home ownership more affordable. On the contrary, the value of the deduction gets baked into the price of homes, often making them less affordable.

Similar research has found that the various tax breaks intended to cover college expenses have not led to more people attending universities. Worse, colleges and universities have raised their tuitions to capture the value of the tax subsidies, making higher education less affordable.

There are also examples in which the repeal of a tax break has had little impact on behavior. For example, prior to the Tax Reform Act of 1986, taxpayers could deduct the interest they paid on car loans and credit cards. The Act repealed the deduction, but people still buy cars and use credit cards today without a thought of deducting the interest. (On the flip side, lawmakers have tried to induce people to purchase electric vehicles with a $7,500 tax credit, yet EV sales are flagging.)

Lawmakers also may be unaware that charitable donations have never been the main source of income for most nonprofits. In 2021, for example, IRS data shows that charitable contributions composed just 14% of the total revenues for §501(c)(3) nonprofit organizations. By contrast, program-service revenues—which include such items as tuition, TV broadcast income, royalties, Medicare and Medicaid payments, payments from insurance companies, and ticket sales—composed 66% of nonprofit income. Government grants accounted for another 10% of nonprofit income.

To be sure, there are small nonprofits, such as food banks and women’s shelters, that do survive solely on charitable donations. But creating an above-the-line deduction for all taxpayers will not guarantee that these charities will receive any more donations than the big tax-exempt hospitals and universities that operate more like corporations than benevolent organizations.

Finally, advocates point to the 2020 CARES Act as their proof of concept. The Act created a temporary charitable deduction for non-itemizers worth $300 for singles and $600 for married couples. However, while 41 million taxpayers claimed the credit, they added only $10.6 billion in additional contributions to the $205 billion claimed by itemizers. The average additional donation was $258. It is impossible to say how many taxpayers claimed the deduction for contributions they would have made anyway.

Subsidy and Charity

Expanding the charitable deduction is not a good use of taxpayer subsidies. Taxpayers would be better off with lower tax rates and greater take-home pay.

But if lawmakers are intent on reintroducing this feature to the tax code, they should limit the deductibility of donations to nonprofits that are primarily funded by charitable donations. Conversely, they should deny the deduction for donations made to nonprofits that receive the majority of their income from program-service revenues and operate more like businesses than nonprofits.

Such a limitation would live up to the spirit of the Charitable Act and ensure that the charitable deduction is reserved for truly benevolent organizations.

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This article first appeared in the Giving Review on January 8, 2025.

Source: https://capitalresearch.org/article/a-better-charitable-act-is-cutting-tax-rates-not-creating-another-tax-break/