Compromising the Safety Net: How Limiting Tax Deductions for High-Income Donors Could Undermine Charitable Organizations
Tolan, Patrick E., Jr., Suffolk University Law Review
D. How Giving Has Changed in Response to Tax Changes
"[A]lmost any change in the tax rate schedule ... will tend to have an impact on giving." (197) It is undisputed that direct consequences of a change in tax rates are twofold and include both price effects (looking at the after-tax cost of giving) and income effects (looking at the after-tax disposable income and its impact on ability to pay). What is controversial and unresolved is the relative strength of these competing effects. The salience of the change is another factor that will likely bear on the price effect, so this more recent dimension should also be considered in any tax-reform proposal. (198) To these three dimensions, the author proposes to add economic hardship as a critical consideration. As next discussed, the lessons of the Great Depression and the recent Great Recession convincingly demonstrate that harsh economic times reduce charitable giving and the magnitude of this effect can dwarf both price and income effects of any tax change.
1. The Early Years: 1913-1940
The only relevant changes in the early years were tax-rate changes, which fluctuated frequently and wildly, predominantly spiking due to WWI, the Great Depression, and WWII. (199) Unfortunately, there is not much data about overall giving during these turbulent times, and there appears to be no data stratified by donor income or tax rate. (200) However, because only the wealthy generally paid taxes prior to the 1940s, the overall price and income effects of any tax changes likely applied to this top group. (201)
Estimates of overall giving indicate that donations dropped during the Great Depression from over $1 billion in 1929, to a low of $637 million in 1933, but rebounded to just over $1 billion again in 1940. (202) Although the price incentive for giving increased substantially in 1932--from 25% to 63%--donations continued to drop due to the bad economy and finally reached a low point in 1933. (203) This demonstrates that the economy might be a more influential factor than the price effect.
In addition, when tax rates held constant from 1933 to 1935, overall giving improved annually as the economy improved, so tax incentives cannot account for this increase, but economic improvement could. (204) Then, when tax rates increased again in 1936 (from 63% to 79% top marginal rate) donations increased for two years, dropped one year, then increased again to $967 million. (205) Increased salience and timing to take advantage of the higher rates could account for some of the increased donations in response to a 1935 tax hike that was notoriously called the soak-the-rich tax. (206) But economic recovery could just as easily account for the increased donations because overall income increased in 1936 and 1937, dipped in 1938, and recovered in 1939, paralleling the overall giving trends.
2. The 1940s and the Standard Deduction
In 1942, tax liability was extended to the masses in the form of a 5% victory tax on income over $624 and a reduction of the personal exemption to $500. (207) The changes were accompanied by a media campaign to reach the vast newcomers now subjected to the income tax. (208) Unfortunately, the new taxes were confusing and difficult to collect, so withholding was instituted to enable taxpayers to comply without going through the "complicated" process of preparing and filing a return. (209)
The Individual Income Tax Act of 1944 was supposed to simplify the tax code by allowing a standard deduction instead of detailed itemization of deductions. (210) But, because charitable donation was an itemized deduction, taxpayers using the standard deduction were not able to enjoy any tax benefit from making charitable donations. (211)
Philanthropic organizations feared this would have an adverse impact on donations, but Congress believed simplification of the Code was more important. (212) However, a precipitous drop in donations was unlikely for several reasons. …