For Charitable Contributions
1995 study, Giving
Credit Where Credit is Due: A New Approach to Welfare Funding,
addresses the major economic issues posed by the concept of offering
a tax credit for charitable contributions as a method of privatizing
welfare spending. We find that a tax credit of this kind would succeed
in its principal goal of making welfare spending taxpayer controlled
as well as taxpayer funded.
On the basis
of this finding, we proposed a 100% federal tax credit for individual
contributions to eligible charities. The credit, which would be
available to nonitemizers as well as itemizers and which could be
taken for up to 25% of individual tax liability, would shift the
delivery of up to $115 billion of federal means-tested welfare benefits
from government to private charities.
has prompted a number of questions not addressed by our first study,
including questions about the relative advantages or disadvantages
of other tax-credit proposals. These questions and the answers that
we offer in reply can be summarized as follows:
1. How would the tax credit impact the current level of giving?
Would taxpayers give more or not?
The tax credit would increase the current level of giving and would
do so to the point that some limit on the tax credit would be necessary
in order to prevent too great a loss of tax revenues from occurring.
The exact effect depends on how donors respond to the tax credit
and on the limit that is imposed on contributions eligible for the
Where Credit is Due proposes a limit of 25% of the taxpayer's tax
liability. Our study offers a proposal, under which $115 billion
in new giving would qualify for a tax credit. Senator Dan Coats
has introduced S-1079, which proposes a tax credit for contributions
of up to $500 for single taxpayers and up to $1,000 for taxpayers
Here we offer
a modified version, under which we expect the tax credit to yield
$107 billion in new giving, bringing total eligible giving to $124
billion. We find that the Coats proposal would qualify $68 billion
per year for tax credits.
For both our
proposal and the Coats proposal, the estimates are upper limits
that would be reached gradually over time. We recommend a five-year
phase-out of those government welfare expenditures that the fully
implemented credit is intended to replace.
as yet unresolved, is that of possible geographic disparities in giving:
Poor people who live in poor states or metropolitan regions may be
made worse off as a result of a preference by donors for local giving.
One solution is for Congress to rely on block grants or some other
transfer mechanism to correct this imbalance. (Our original proposal
suggests additional possible remedies.)
2. Would giving increase under a tax credit, or would taxpayers
merely substitute contributions eligible for the credit for contributions
ineligible for the tax credit and pocket the saving?
We do not believe that a tax credit would cause any significant
substitution of eligible for ineligible contributions. Because both
the BHI and the Coats proposal permit charitable contributions not
eligible for the tax credit to remain eligible for the existing
tax deduction, neither increases the price of making these contributions
and therefore neither creates a disincentive to make them.
Even so, there
is a concern that taxpayers would reduce their tax bills by substituting
eligible for ineligible contributions. The more an eligible contribution
could be seen as a substitute for an ineligible one, the more likely
this substitution would take place.
Our answer is
that there is no incentive for taxpayers to reduce their contributions
to any charity, provided only that the tax credit be implemented
as proposed in our December 1995 study - that for every new dollar
contributed to charities deemed qualified to receive eligible contributions,
the government reduce its spending on welfare programs by one dollar.
a number of empirical tests of the validity of this conclusion.
An ideal empirical test would consist of an estimate of the "cross-price
elasticity of demand" between eligible and ineligible charities.
Because of a lack of data, we conduct other tests that provide a
proxy for this elasticity.
tests, we find strong positive correlations between all types of
charitable giving over time, both in nominal and real dollars. We
find giving to religious and human-services organizations to be
complementary goods, meaning that as individuals give more to the
one kind of organization, they give more to the other.
foregoing assurances, there may still be concerns about possible
substitution of eligible for ineligible contributions. To allay
these concerns, we offer a modification of our original proposal.
Under this modification, the taxpayer could not take a credit for
any contribution during the current year unless ineligible contributions
were at least as great as they were during the preceding year. We
offer a Welfare Tax Credit worksheet that shows how this rule would
work and how it would prohibit the substitution of eligible giving
for ineligible giving.
3. Should there be a threshold limit of giving for tax credit
The appropriate threshold, which would both eliminate substitution
and assure revenue neutrality, is the one offered above in our answer
to Question 2: Contributions not eligible for a credit would have
to be at least as great in any given year as they were in the previous
year in order for "welfare" contributions to be eligible for a credit.
A threshold of this kind brings about the desired increase in eligible
giving while deterring taxpayers from decreasing ineligible giving.
4. Because the BHI proposal permits qualified donations in excess
of the 25% maximum to be tax deductible, it creates a potential
circularity problem in computing the tax credit and thus the tax
due. How can this problem be resolved?
We resolve this problem by converting donations in excess of the
maximum into a partial credit based on the taxpayer's marginal tax
rate. The total tax credit then equals this partial credit plus
25% of the taxpayer's tax liability.
5. What is the appropriate role of solicitation organizations
in delivering welfare benefits?
The BHI proposal does not permit donations to solicitation organizations
(such as the United Way) to qualify for tax credits. The reason
is that such organizations represent an administrative "filter"
that absorbs funds better spent directly on the poor.
The Coats proposal,
on the other hand, allows credits for donations to solicitation
organizations. There are reasonable arguments, including economies-of-scale
and quality-control arguments, that can be made in support of this
that charitable organizations would develop their own funding networks
and quality-control arrangements without the need for solicitation
intermediaries. The question is, however, open to further research.
6. Is the idea of a tax credit compatible with that of a flat
There is no practical incompatibility between the flat tax and the
idea of offering tax incentives, even tax credits, for charitable
contributions. The reason is that such incentives do not interfere
with the core purpose of a flat tax, which is to shift the burden
of the tax from saving to consumption and to increase economic efficiency.
Congressional Testimony by
Prof. David G. Tuerck
Policy Study: Giving
Credit Where Credit is Due: A New Approach to Welfare Funding
Transcripts from BHI's Compassionate
Welfare Reform Conference, December 12, 1996, Washington D.C.