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Untouchable Status of Charitable Deduction: Dwindling Under Tax Reform Pressure, BNA's Daily Tax Report

April 17, 2013

Reproduced with permission from Daily Tax Report, 73 DTR G-6 (Apr. 16, 2013). Copyright 2013 by The Bureau of National Affairs, Inc. (800-372-1033) <http://www.bna.com>

By Diane Freda

The charitable deduction will be a target when tax reform negotiations get under way on Capitol Hill, and it does not matter which political party prevails, one of several pundits at an April 15 Urban Institute forum said.

"The kinds of public programs that do good things for worthy people are under very severe assault, and not just under the Ryan budget, but at the hands of President Obama's budget as well," said William Galston, senior Brookings Institution fellow and a former Clinton administration official.

For the fifth consecutive year, Obama's fiscal year 2014 budget has proposed to limit the value of the charitable deduction at 28 percent for high-income taxpayers (70 DTR GG-5, 4/11/13). House Budget Committee Chairman Paul Ryan (R-Wis.) proposed a Republican budget resolution for FY 2014 that does not include a similar cap, but would curb tax expenditures in other ways.

The net political effect of the end of the year deal on the Bush tax cuts was to take further increases in marginal tax rates off the table, Galston said. "What that tells me is that base-broadening will be the name of the game in tax reform, whether the reform is revenue-neutral or revenue-raising."

As fiscal pressures mount, the charitable deduction, which may previously have received special consideration because of its philanthropic purpose, is not likely to remain sacrosanct

Not Picking on Charities

"The fickle finger of fate is pointed in the direction of the sector," he concluded. "You're not being singled out for special abuse, but neither are you automatically exempt from contributing what some legislators consider your fair share."

While charities like to think of themselves as do-gooders, the idea that their activities should be protected because they help the poor and needy will go out the window as lawmakers hunt and scratch for every conceivable dollar to fill the gaping revenue hole.

There is now bipartisan acceptance of the debt-to-gross domestic product ratio as an indicator of fiscal sustainability, as well as bipartisan acceptance of the need to at least stabilize that ratio over the next decade, if not get it down, Galston said. The United States has now witnessed the single largest increase in that ratio in the entire post-war period.

In the face of growing pressure for fiscal restraint at the federal level, relentless entitlement spending, and less defense and non-defense discretionary spending in Obama's 2014 budget, he suggested that every tax expenditure will be on the table.

Separate Approach Needed for Each Tax Expenditure

Obama's one-size-fits-all approach to dealing with tax expenditures has not found universal acceptance.

"The problem with using the same rule for all tax expenditures is that they are different programs with different purposes and different incentive structures," Eugene Steuerle, an Urban Institute fellow, told BNA. Steuerle was one of more than a dozen public policy experts who spoke on the Urban Institute panel on charity, the government, and tax reform.

The charitable deduction would ideally provide incentives at the margin, he said, encouraging people to give more. But that same approach would not work with health insurance, for instance, where the government is providing a subsidy designed to encourage people to buy insurance, but not necessarily the biggest or most expensive plan. "With one tax incentive, you might want a cap, and with another you might want a floor," he said, where employing an across-the-board cap applies the same rules to every tax expenditure that is an itemized deduction.

Ugly Statistics

If the charitable deduction were capped at 28 percent, Arthur Brooks, president of the American Enterprise Institute, said his best estimates indicate that all charitable giving would decline by 4.5 percent in the first year it was enacted.

Secular giving to nonreligious organizations would decline by 7 percent, he predicted. Giving to religious organizations would decline by 1 percent; giving from people who itemize would decline by 9 percent; and giving to organizations that get their contributions from the top 1 percent of the income distribution would fall by 24 percent.

"It's a big deal," he said. "You're a hospital, you're a university, you're a think tank, the effect would be catastrophic if these estimates are even close to reality, and I am quite convinced that they are."

While attempts to define what "charity" is eluded some members of the panel, Alex Reid, an attorney with Morgan, Lewis & Bockius, and a former legislation counsel for the Joint Committee on Taxation, defined it simply as "generating public benefit, without significant private benefit."

He said the charitable deduction should not be considered a subsidy at all, because subsidies involve government control.

"The tax law quite correctly leaves the definition to the marketplace, to the American people, and how the American people want to help out," he said. "But the government's role is to be a neutral arbiter to insure that charities are organized and operated to perform a public benefit, and the private benefit is screened out to the extent possible."