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The Obama Budget Proposal: Tax Increase on Charity

April 10, 2013

By Howard Husock

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President Obama’s long-awaited budget proposal, to be released today, does not come right out and say that it intends to reduce contributions to charity—but that is almost certainly what would happen were it to become law. Here’s why. The White House has effectively doubled down on a tax change it has been pushing for four years that would limit the value of the charitable tax deduction. The Administration has, since 2009, pushed unsuccessfully to allow only 28 cents on a dollar donated to charity to be deducted—even though the top tax rate for the wealthy donors who make most use of the deduction has been 35 percent. In the budget released today, the President again proposes to cap the charitable deduction at 28 percent—despite the fact that the top rate on the highest earners has increased to 39.6 percent. Think of it this way: the White House proposal would raise the cost of giving to charity from 60 cents per dollar to 72 cents per dollar. That’s a 20 percent increase in what can be called the "charity tax."

When one taxes something more, of course, one gets less of it—and it’s likely that the current $168 billion in itemized charitable giving would decline. Indeed, Indiana University’s Center for Philanthropy has previously estimated that capping the charitable tax deduction’s value at 28 percent—even when the top income tax rate was 35 percent—would lower giving by 1.3 percent, or some $2.18 billion in 2010. The new proposal would likely take an even bigger bite from giving. The Chronicle of Philanthropy reports that the reduction in giving could be as high as $9 billion a year.

For the Obama White House, this is a matter of tax fairness—in keeping with the Administration’s overall proposal to cap the deductibility of other significant tax expenditures, notably the home mortgage interest deduction and the deduction for state and local taxes. These, like charitable donations, are typically used to the greatest extent by the most wealthy taxpayers who, the Administration has reminded us time and again, should, in its view, pay their "fair share."

But all these tax deductions are not created equal.

The home mortgage interest deduction, for instance, which reduces tax revenues by some $70 billion annually, has the perverse effect of driving up home prices and providing the greatest benefit to those with the most expensive homes. It’s used, moreover, as an argument by advocates for increased housing subsidies for low-income families—which have their own perverse effects, increasing dependency and discouraging work (as I’ve written in City Journal). Those liberal critics are right. If we want to increase home-ownership—a tricky goal, as the bursting of the housing bubble taught us—an open-ended mortgage interest deduction is not the best way to do so.

So, too, with the deduction for state and local taxes, which decreases federal tax revenues by some $43 billion annually. As my Manhattan Institute colleague Stephen Eide has observed, in his paper entitled Could Tax Reform Defund the "Blue State Model"?, these deductions make it easier for free-spending politicians in New York, Illinois, California and other high-tax jurisdictions to continue their profligacy, because their upper -income taxpayers don’t feel the full bite of high income and sales taxes.

Is the charitable tax deduction really different? Fundamentally, the answer is yes. Although it decreases the tax liability of the affluent, it provides no direct personal benefit that’s the equivalent of a McMansion or gold-plated local schools or parks. It’s true that it leaves more money in taxpayers’ pockets to spend as they wish—but that’s only because of the social benefits their donation is providing, whether in the form of a food pantry or medical research. Indeed, without saying so explicitly, the Obama charity tax increase implicitly assumes, under cover of "fairness," that Washington will do a better job spending the money than private donors will. But by encouraging philanthropy, we encourage imagination and innovation—in ways the political process, more likely to be constrained by conventional wisdom, will not.

For example, it’s not easy for the federal Department of Education to tell the public that a college education might, in some cases, be counter-productive for young entrepreneurs. But, in his role as a philanthropist, serial entrepreneur Peter Thiel (eBay, Facebook), did just that, when his foundation offered $100,000 for students with the best business plans—who would agree to drop out of school. Of course, it’s quite possible that Thiel would have done the same thing even if the value of the charitable deduction were slightly lower, as the White House proposes. But many less wealthy donors to local causes—including start-up nonprofits with good new ideas—might well be deterred.

The charitable tax deduction is far from perfect, as it stands. It creates the opportunity for mischief—as when liberals such as Stanford University’s Rob Reich suggest that it be limited only to donations which have a direct, redistributional effect. Indeed, America could, arguably, be better off with a far simpler tax code, characterized by lower rates—and the higher economic growth which would likely result. It’s new wealth which ultimately most fuels charitable giving, after all. Another possibility: the straight charitable tax credit—which would benefit anyone owing federal income taxes; that was actually proposed by the President’s own Simpson-Bowles deficit reduction commission. No such proposal has been offered by the White House, however—which apparently is willing, instead, to decrease charity in order to increase federal spending. Let’s hope that the House and Senate have the wisdom not to go along.

Original Source: http://www.forbes.com/sites/howardhusock/2013/04/10/the-obama-budget-proposal-new-tax-on-charity/

 

 
 
 

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