The Great Recession, tax policy, and the future of charity in America

Charitable giving by Shutterstock.com

Article Highlights

  • Given the importance of charitable contributions, it's no surprise they have been a focus of public finance research.

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  • The charitable deduction cap will have a large negative impact on giving predicts @ArthurBrooks

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  • Charitable giving in the US is generally estimated to be about $300 billion, a level first attained in 2007.

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Abstract:

A great deal of research has studied the effects of income and tax changes on charitable giving. However, little work has focused on these relationships in the wake of the Great Recession. This paper estimates the price and income elasticities of giving using the 2009 Panel Study of Income Dynamics (PSID). The estimates are notably different than the typical findings from before the recession. Most importantly, price elasticity is much higher (in absolute terms) and income elasticity is lower. These unusual patterns are much more pronounced for secular giving than for religious giving, and the effects are much more muted when only considering itemizers. The elasticity estimates are used to develop policy analytic results, considering the likely effects of the 2013 personal income tax rate increases and possible tax deduction limits currently under consideration by the Obama Administration. I find the tax increases to have a moderately stimulative impact on giving, but predict the deduction cap will have a large negative impact.

 

Introduction:

Nonprofit and voluntary activities are central to the provision of public goods in America, and are as old as the Republic itself. Indeed, this has long struck outside observers as unique. In what is probably the most famous passage from Democracy in America, Alexis de Tocqueville wrote in 1835 that, "The Americans make associations to give entertainments, to found seminaries, to build inns, to construct churches, to diffuse books, to send missionaries to the antipodes; in this manner they found hospitals, prisons, and schools."2 He went on to make an explicit distinction from the Europeans: "Wherever at the head of some new undertaking you see the government in France, or a man of rank in England, in the United States you will be sure to find an association."

American tax law's accommodation of philanthropy can be seen, therefore, as an expression of the social contract. The imposition of the individual income tax in 1913 was quickly followed in 1917 by the charitable deduction that we still see today. The Congressional debate on this policy contains this argument from an unidentified Congressman: "If a man wants to make a gift to charity, he ought to be encouraged to do so and not [be] discouraged. He ought to be encouraged to make such a gift rather than be penalized for doing so." (Desmond 1967)

In effect, deductions for charitable contributions were an acknowledgment that public goods in America have always been, in no small part, a private endeavor. As such, the taxes foregone on contributions to qualifying charities were a way for private citizens to direct public resources in exchange for their own investments. This is in contrast to the notion that charitable contributions are, in modern parlance, "tax loopholes."

"Given the importance of charitable contributions for the provision of public goods, it is no surprise that they have been a focus of public finance research." -Arthur Brooks Given the importance of charitable contributions for the provision of public goods, it is no surprise that they have been a focus of public finance research. In particular, economists have studied the impact of income, as well as the "tax price of giving," on donations.

The tax price of giving is defined as 1−τ , where τ is the marginal tax rate, and charitable contributions are tax-deductible. When the tax rate increases, the deductible portion of a contribution increases by the same amount, so the effective price of the contribution falls. For example, if t is 25 percent and a taxpayer donates a dollar, his taxable income falls by the dollar and this saves him 25 cents in taxes—making the price of the contribution (1−τ ), or 75 cents.

The effects of income and tax price on giving are generally studied in terms of elasticities. The price elasticity of giving shows how tax policy will affect the nonprofit sector and allows us to predict the effects of changes in tax rates to donation levels. The income elasticity allows us to predict the rates of growth in the sector as disposable income GDP grows.

 

These elasticities have been calculated many times in the literature, and the results have been fairly stable for decades. However, we have every reason to doubt that this is still the case in the wake of the Great Recession of 2007-2009.

These elasticities have been calculated many times in the literature, and the results have been fairly stable for decades. However, we have every reason to doubt that this is still the case in the wake of the Great Recession of 2007-2009.

Elasticities calculated in the 2008-2009 period can help provide insight into the effects on giving from recession, macroeconomic instability, and policy uncertainty. This has important policy implications in an era in which policymakers are questioning longestablished policies such as the tax-deductibility of charitable donations and the role of government in providing many charitable public goods.

This is the first paper to estimate price and income giving elasticities during the 2008- 2009 recession. After surveying the literature and summarizing the recent trends in American charitable giving, I use the 2009 data from the Panel Study of Income Dynamics/Center on Philanthropy Panel Study to produce the latest and to date, only, elasticity estimates for this period. The estimates show that donations are indeed less responsive to income and the price of giving than in the past. These results yield implications for both policy and management.

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Arthur C.
Brooks

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