Compromising the safety net: how limiting tax deductions for high-income donors could undermine charitable organizations.

• Author: Tolan, Patrick E., Jr.
• Position: I. Introduction through II. Background C. Charitable Deductions Evolution Throughout the Years, p. 329-363

1. INTRODUCTION II. BACKGROUND A. The Charitable Donation Deduction: Then and Now 1. Inception of the Charitable Donation Deduction 2. Present Deductibility 3. 2013 Budget Proposal and Expiring Tax Cuts B. Justifications for the Deduction 1. Ideal Income Tax Excludes Charitable Donations from Income 2. Efficient Subsidy Theory 3. Equity Theory 4. Distributive Justice: Rawls Revisited 5. The Need for Salience C. Charitable Deduction Evolution Throughout the Years 1. Changes to Limit Deductions as a Percentage of Income 2. Changes to the Pool of Tax-Advantaged Donors 3. Rate Changes Throughout the Years a. Early Tax Rates: Wartime Spikes and Progressivity b. Major Rate-Change Reforms of the 1980s c. Post-1980s Rate Changes: Increases, Relief, and Sunsets D. How Giving Has Changed in Response to Tax Changes 1. The Early Years: 1913-1940 2. The 1940s and the Standard Deduction 3. Changes in the 1950s-1960s 4. Changes in the 1970s 5. Tax Reform in the 1980s 6. The 1990s to the Present III. DONATIONS DROP IN TIME OF SERIOUS RECESSION IV. ANALYSIS AND RECOMMENDATIONS A. The Charitable Deduction Should Not Be Reduced Now B. Severity of Proposed Tax Reform C. The Need for Continued Study V. CONCLUSION APPENDIX 1 "Charity is thus a blessed act that should suffer no discouragement from something so mean as the tax code." (1)

1. Introduction

   More Americans--46 million--are presently living in poverty than at any time in the past fifty years. (2) Even more disturbing, child-poverty rates have climbed to 22%, up from 16% just ten years ago. (3) As demand for social services peaks, many newly unemployed or others who have never before needed social services will turn to charities, specifically their churches, for services because they do not know about public assistance or how to obtain it. (4)

   "Superstorm sandy" reminds us of how vulnerable people are to natural disasters as well as the critical role of nonprofit organizations in providing relief to disaster victims. (5) Nevertheless, whether our hardships are from natural or economic disasters, what is most evident is the crucial need for the services of the charitable sector to help those who are suffering.

   Despite America's unparalleled modern economic hardship, President Obama has proposed reducing tax relief for wealthy taxpayers who donate to charity. (6) To the extent these changes could deter charitable giving, the government could unwittingly undermine the nonprofit safety net that insulates the government from being the only provider for the impoverished. (7)

   The charitable donation deduction is different from other personal deductions because the beneficiaries include not only the donor, but also the charitable organizations and especially those they serve. Therefore, it should not just be lumped in with restrictions on other itemized deductions. Instead, consequences of a cap on deductions to the charitable sector must be intrinsic to any discussions impacting donations to the charitable sector so that our national leaders do not make ill-advised decisions, especially in the face of a struggling economy and peaking demands for charitable assistance.

   This Article considers several rationales for allowing charitable donations and analyzes the potential consequences of implementing President Obama's budget proposal. America's largest donors are those in the highest marginal tax brackets; thus, efforts to limit the deductibility of their charitable donations could have a chilling effect on charitable giving. (8) This could be especially troublesome in our recent down economy, at a time when donations overall have dropped due to the recession and have never recovered. (9) Looming threats of another fiscal crisis or economic slowdown due to rising national debt could make matters worse before they get better. (10)

2. BACKGROUND

   At the outset, it is appropriate to provide a brief introduction to the general tax scheme concerning deductions for charitable donations. This Part considers what the Treasury has done historically and its reasons for doing so, while the impacts of changes in the tax scheme are addressed later. This Part also addresses the current tax treatment of charitable donations as a framework for understanding how the proposed changes would depart from the status quo. Finally, this Part discusses the details of the changes in the 2013 budget proposal.

   1. The Charitable Donation Deduction: Then and Now

      1. Inception of the Charitable Donation Deduction

         The tax deduction for charitable donations has been around for almost one hundred years (11)--nearly as long as the Sixteenth Amendment has allowed direct taxation of individual income. (12) The charitable donation deduction was one of the earliest allowable personal tax deductions, initially serving as a reprieve from the wartime burden of income taxes on the wealthy in World War I (WWI). (13) As originally enacted in the War Income Tax Revenue Act of 1917, the deduction extended to organizations "operated exclusively for religious, charitable, scientific, or educational purposes, or to societies for the prevention of cruelty to children or animals." (14)

         The chief proponent of the charitable donation deduction was Senator Henry F. Hollis, who asked that a series of editorials in favor of the proposal be admitted to the Congressional Record. (15) His remarks are introduced here to put the deduction in its proper historical context, but the implications of his remarks are discussed later in concert with the various policy justifications for the deduction. These arguments have been used to support the efficient subsidy justification embraced by some commentators for such deductibility, but a more comprehensive review of the record reveals other concerns that afford additional historic justifications for the deduction. (16) A deeper understanding of the full panoply of values motivating the addition of charitable-donation relief to the tax code is consistent with myriad justifications for the donation, as well as the mixed motives that stimulate donor behavior. The following remarks demonstrate these plural and incommensurable values:

         If the Government takes all, or nearly all, of one's disposable or surplus income, it must undertake the responsibility for spending it, and it must then support all those works of charity and mercy and all the educational and religious works which in this country have heretofore been supported by private benevolence. (17) The tax deduction for charity is consistent with the principles of American democracy espoused in the nineteenth century by Alexis de Tocqueville that America's greatness depends on individual and community responsibility, not the federal government. (18) It is no surprise that as direct taxes on individual income became constitutional, Congress was mindful of protecting individual ability and autonomy to donate to charitable organizations in order to preserve the social-support function in private and community hands. Even before taxes became necessary to fund the war effort in 1917, Congress had proposed tax relief for charitable donations. (19) These efforts were consistent with de Tocqueville's framework of American greatness: the preference for small central government and an engaged individual and community role in charity. (20)

         Of course these protections for charitable donations were put in place before major social reforms enacted during and after the Great Depression. (21) While the Great Depression prompted social legislation, and initiatives like the Great Society were "major leaps forward" in formulation of a government safety net, even after these reforms, "at heart ... [Americans] favor private charity over government dole." (22)

      2. Present Deductibility

         Internal Revenue Code [section] 170 outlines the deductibility of charitable donations and allows an itemized deduction for cash and noncash donations to charity. (23) "An important effect of this provision is to lower an individual's net cost of making gifts." (24) Although the United States has experimented with allowing a deduction for charitable donations for nonitemizers, Congress eliminated this deduction when comprehensively recodifying the tax laws in 1986. (25) Therefore, the Code currently only allows those itemizing deductions to write off their charitable gifts. The substantial increase in the standard deduction in 1986 also significantly reduced the number of taxpayers who itemize their deductions. (26)

         If an organization does not qualify for an exemption as described in [section] 501(c)(3), donors may not deduct contributions under [section] 170.27 To qualify for exemption under [section] 501(c)(3), an organization must demonstrate both that it is organized and operated exclusively for exempt purposes, and that no part of its earnings inure to private individuals. (28) In addition to the prevention of cruelty to children or animals and the promotion of amateur sports, these organizations are formed for a variety of reasons including "religious, charitable, scientific, testing for public safety, literary, or educational purposes." (29) The IRS scrutinizes applications for [section] 501(c)(3) status to ensure organizations, particularly foundations, are not established to benefit the donor/founder. (30)

         Cash contributions follow comparably easy donation rules and limits, while noncash gifts of appreciated property follow more complex rules. For cash donations to a public charity, individuals can deduct up to 50% of their contribution base--modified adjusted gross income (AGI)--in the present tax year and donations in excess of this amount may be carried forward as deductions for up to five succeeding tax years. (31) On the other hand, most gifts to private foundations are limited to 30% of the taxpayer's contribution base (with any surplus also being carried forward for up to five tax years). (32)

         Contributions of appreciated capital assets to public charities are...