It started out innocently enough. We were at a Friday night poker game, and the conversation turned to the various proposed federal budget cuts that seemed to be flying everywhere. Everybody agreed that with the massive deficit nothing was sacred; nothing was safe.
"What about you guys, Jack?" my friend across from me asked. "You nonprofit guys seem to be sitting on your hands. When are you going to have a horse in this race?"
"Well," I answered cautiously, "there's not a heck of a lot we can do. Obama has suggested a reduction in the top tax deduction for gifts to charity, but I've got to admit that's not very popular inside the nonprofit world, especially in this economy."
My friend scoffed. "Very thoughtful. I guess we'll just have to be content to cut Medicare, social security, unemployment insurance, and hot lunches for poor schoolchildren."
Stung, I retreated to my computer, where I spent more than a hundred hours reading research papers, reports from the Joint Committee on Taxation, Office of Management and Budget, Giving USA, Harvard and Boston College Law School journals, Tax Notes, Tax Policy Center, and the Council on Taxes and Philanthropy, among others.
I emerged with a section of the tax code that handcuffs nonprofit organizations from advocating for the very constituencies they were created to serve; costs more than $30 billion a year; is available only to the wealthy; is subject to pervasive abuses that cost even more billions; just might be at least technically unconstitutional under provisions of the First Amendment; and, to top it all off, has never been able to demonstrate that it accomplishes the primary purpose for which it was created.
This is the charitable tax deduction.
Armed with this information, I wrote an opinion piece in the Sunday Los Angeles Times that said that the charitable tax deduction had outlived its usefulness and should be abolished.
My editors at the Times really liked the piece, calling it a new idea—pioneering, even.
I quickly learned the truth in my grandmother's admonition about new ideas. "You can always tell the pioneers, Jack. They're the ones with the arrows in their chests."
I got plenty of arrows (and a few bouquets), perhaps because after having spent most of my adult life in the nonprofit sector, I was seen by some as a quisling, a rabble-rouser, or worse (at least for me), a flat-tax tea party Republican (gulp).
For almost a hundred years, we've been taking for granted that the charitable tax deduction stimulates giving. But what if we're wrong?
First, a little history. The charitable tax deduction was one of the first federal tax deductions, enacted in 1917. It was created to help the war effort by underwriting gifts to the War Chest (the precursor of the United Way) and the Red Cross. When World War I ended, the charitable tax deduction was continued. Nobody thought much about it one way or the other, because fewer than 10 percent of Americans paid taxes, and the top rate was 7 percent.
But both the tax rates and the number of those being taxed increased greatly, until by World War II fully 70 percent of us were paying taxes and drowning in paperwork. Congress started looking for a simpler way, a standard deduction.
But in 1944, when Congress began debating a standard deduction short form for taxes, it dawned on leaders of churches, the Red Cross, and community chests that such a short form would end the charitable deduction. They rushed to Washington in panic. Replacing the long form charitable tax deduction with a short form where the deduction is assumed would spell the end of gifts to the nonprofit world, they argued. Congressman Carl Curtis said such a change would "cripple all of these worth-while [sic] institutions so that they must come to the Federal Government for a subsidy."
Senator Walter George, then chair of the Senate Finance Committee, wasn't moved. "The committee does not believe that it can be proved that a tax incentive has been an important factor in the making of such gifts," he said. The Individual Income Tax Act of 1944 was passed, and charitable contributions did not decline.
In 1981, when Congress was debating a new tax bill that would drop the top tax bracket from 70 percent to 50 percent, almost doubling the cost of charitable gifts among top-bracket donors, nonprofits screamed bloody murder. Economist Charles Clotfelter wrote, "As debate over tax reform intensified [. . .] the treatment of charitable contributions provided some of the gloomiest predictions and most heated debate among the provisions involved in tax reform during the 1980s." The Economic Recovery Tax Act of 1981 passed anyway, and charitable contributions did not decline.
In 1992 and 2003, when the top bracket for individual taxpayers was dropped again—first to 39 percent and then to its current 35 percent—nonprofits once more predicted that the sky was falling. The "opportunity costs of virtue" would go up, dealing charity a terrible blow, they said. But charitable contributions did not decline.
Then, last October, in response to President Obama's suggestion that Congress lower the top charitable tax deduction to 28 percent, Senate Finance Committee chair Orrin Hatch held hearings on the proposed reduction, and got an earful.
United Way of America's Brian Gallagher issued the stern warning that if the charitable tax deduction were lowered from 35 percent to 28 percent, "You should expect that donors will simply withhold the difference to cover the tax."
Are you beginning to see a pattern here?
Gallagher's argument seems logical and has been used many times, but statistics don't bear it out. As the top tax bracket goes down, the individual cost of giving, at least among the wealthy, goes up, so contributions should decline. But they don't. According to Giving USA, individual charitable giving over the past quarter-century has remained solid as a rock, hovering between 1.7 and 1.95 percent of personal income year after year. This has some people asking that if giving didn't decrease when rates went from 70 percent to 35 percent, why would it go down by lowering the rate to 28 percent?
The truth of the matter is that after almost a hundred years in place, nobody can say for certain how much, or even if, the charitable tax deduction affects giving. But, oh, the hoops we nonprofits have to go through to qualify for tax-deductable gifts.
Many researchers have been warning for decades that the charitable tax deduction doesn't appear to be an incentive to giving. According to the Encyclopedia of Taxation and Tax Policy, William C. Randolph of the Congressional Budget Office, referring to the now ancient and unreliable 1985 Clotfelter study, suggested that "studies have generally overstated the degree to which the subsidy increases giving, which weakens, somewhat, its economic policy justification." In other words, it doesn't work. Randolph states that in some cases it seems to work in reverse, but doesn't give examples. Using enough econometric charts and graphs to choke a medium-size pony, Randolph demonstrates that differing tax subsidy rates have a temporary effect on giving (some donors front-end load their giving to take advantage of a higher deduction one year), but it quickly evens out and has no permanent effect.
So even though government subsidies of gifts to charity probably don't increase nonprofit coffers, we must accept second-class corporate citizenship to earn this phantom largesse. Nonprofits can't lobby, can't make contributions to anyone running for office, can't actively support one candidate over another, and can't contribute to a political action group. Even if we try to increase citizen participation by increasing voter registration, we’d better be damn sure it's nonpartisan and multistate. Even that might not save you (ACORN, anybody?).
What makes these prohibitions particularly galling is the decision last year by the Supreme Court that in matters of free speech, corporations are people—except nonprofit corporations, that is. Big Pharma can spend as much to influence elections and legislation as it wants, but the Boy Scouts can't spend a nickel. Is that fair? Nonprofit executives, by the way, are the only segment of American corporate life who can be sanctioned by the IRS for excessive compensation. Try flying that one past Wall Street.
Although it would save a quarter of a trillion dollars over the next decade with little or no impact on charity, abolishing the charitable tax deduction probably won't happen. It's a third-rail issue to politicians, who would just as soon not fight the Catholic Church, the Girl Scouts, the Red Cross, and every university development office in the country in order to get reelected.
But nonprofit corporations should be afforded the same freedom of expression allowed all other corporations. The federal charitable tax deduction doesn't work, comes with too many strings attached, and should be abolished. Although it goes against conventional wisdom, the biggest winners of its abolition may well be the very churches, United Ways, universities, and other nonprofits the charitable tax deduction was established to subsidize.
Jack Shakely is president emeritus of the California Community Foundation in Los Angeles and a senior fellow at the Center for Philanthropy and Public Policy at the University of Southern California. He is also Gold Medal winner of the 2009 IPPY Book of the Year Award in Historical/Military Fiction.