How do we distribute tax benefits for charitable donations?

A lot of us, including myself, are hurrying to write those end of year tax-deductible contributions before December 31. I'm personally grateful that our tax system, as imperfect as it is, makes it possible to support my favorite charities at lower out of pocket cost than would otherwise be possible.

But I'm struck by the remarkable generosity of many of the low-income taxpayers at our Union College Volunteer Income Tax Assistance (VITA) site, who rarely get any tax benefits for their donations.

In today's New York Times, University of Chicago economist Richard Thaler gives a thought-provoking description of how our tax system treats the donations of the rich and the poor.

Consider this scenario: Having decided that charitable giving is a worthy cause, the government subsidizes charitable gifts from certain households, and for those chosen to be part of the plan, every dollar donated to a charity is increased by a specified percentage. To qualify, taxpayers must have a substantial home mortgage; the subsidy rate increases with taxable income. Low-income taxpayers receive no subsidy, but donations from qualified high-income taxpayers are subsidized by as much as 40 percent — or more.

At this point, you may be wondering why I’d even mention something so preposterous. After all, why should a family’s eligibility for a donation subsidy depend on whether it has a large mortgage? And why should the government subsidize donations by the rich more than donations by the poor? The idea seems a nonstarter. And it would be, if not for one important detail: it is (approximately) the current law.

The whole article is very much worth reading.

My Union College student volunteer tax preparers see this scenario play out on a daily basis every year during tax season. The overwhelming majority of our taxpayers do not itemize, either because they do not own homes, or because they are elderly homeowners who have paid off their mortgages. Therefore giving a dollar to charity leaves them out of pocket by the full dollar. A tiny minority of our taxpayers are homeowners with mortgages and property taxes sufficient to justify itemizing. Because we are limited to serving taxpayers with incomes below $49,000, they would typically be in the 10% or 15% tax bracket, so the cost of giving a dollar might leave them out of pocket by 85 or 90 cents. Higher income Americans might be in the 35% tax bracket, meaning that the dollar they give to charity effectively costs them only 65 cents.

("But wait!" as they say on late night TV, "There's more!" The highest income Americans may also receive additional tax benefits from their donations: they may be able to escape income on unrealized capital gains by donating appreciated property to charity, as well as doing a variety of clever strategies to reduce their estate taxes.)

Another NYT article earlier this year sheds further light on this issue:

For decades, surveys have shown that upper-income Americans don’t give away as much of their money as they might and are particularly undistinguished as givers when compared with the poor, who are strikingly generous. A number of other studies have shown that lower-income Americans give proportionally more of their incomes to charity than do upper-income Americans. In 2001, Independent Sector, a nonprofit organization focused on charitable giving, found that households earning less than $25,000 a year gave away an average of 4.2 percent of their incomes; those with earnings of more than $75,000 gave away 2.7 percent.

This situation is perplexing if you think of it in terms of dollars and cents: the poor, you would assume, don’t have resources to spare, and the personal sacrifice of giving is disproportionately large. The rich do have money to spend. Those who itemize receive a hefty tax break to make charitable donations, a deduction that grows more valuable the higher they are on the income scale. And the well-off are presumed to have at least a certain sense of noblesse oblige. Americans pride themselves on their philanthropic tradition, and on the role of private charity, which is much more developed here than it is in Europe, where the expectation is that the government will care for the poor.

But in the larger context of “the psychological culture of wealth versus poverty,” says Paul K. Piff, a Ph.D. candidate in social psychology at the University of California, Berkeley, the paradox makes sense. Piff has made a specialty of studying those cultures in his lab at the Institute of Personality and Social Research, most recently in a series of experiments that tested “lower class” and “upper class” subjects (with earnings ranging from around $15,000 to more than $150,000 a year) to see what kind of psychological factors motivated the well-known differences in their giving behaviors. His study, written with Michael W. Kraus and published online last month by The Journal of Personality and Social Psychology, found that lower-income people were more generous, charitable, trusting and helpful to others than were those with more wealth. They were more attuned to the needs of others and more committed generally to the values of egalitarianism.

For more information on this topic, including a revealing graph showing how much it costs, on average, for people in different income categories to give a dollar to charity, see this earlier post on my blog, discussing an article written by Williams College economist Jon Bakija and Treasury Department Office of Tax Analysis economist Bradley Heim, "How does charitable giving respond to incentives and income: Panel Estimates with State Tax Identification, Predictable Tax Changes, and Heterogeneity by Income."