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Why Should There Be a Tax Deduction for Charitable Giving?

- April 18, 2008

bq. The first justification is that the deduction is necessary in order to account for the proper base of taxable income; the deduction, in other words, is no subsidy at all. The second justification is that the deduction efficiently stimulates the production of public goods and services that would otherwise be undersupplied by the state. The third justification links the incentive to the desirable effort to support a pluralistic civil society in a flourishing democracy. I believe that only a version of this third argument stands up to scrutiny.

That is from this paper by Rob Reich, a political theorist at Stanford. The puzzle arises in part because the deduction costs the U.S. government a substantial amount of tax revenue:

bq. Because the tax deduction constitutes a subsidy – the loss of federal tax revenue – it is no exaggeration to say that the United States currently subsidizes the liberty of people to give money away, foregoing tax revenue for an activity that for millennia has gone unsubsidized by the state. Charitable giving in 2006 was just shy of $300 billion, costing the U.S. Treasury roughly $50 billion in lost tax revenue.

In a recent talk at GW, Reich also discussed notable flaws in the current implementation of this deduction. For example, it can be claimed only by those who itemize deductions (a minority of taxpayers). So if Reich and I each give $100 to Oxfam, but only he itemizes, only he gets a deduction. Reich says:

bq. Thus the subsidy is capricious, for its availability depends on a characteristic, one’s status as an itemizer, that has nothing whatsoever to do with the value of giving.

Reich also raises questions about the ways in which this deduction can encourage inequality. See his discussion of charitable foundations for public schools in this New York Times article. In essence, parents can set up these foundations and claim their donations as tax deductions. The state subsidizes a means by which schools whose students come from wealthier families can improve even more.

This is not a thorough summary of Reich’s argument, of course. See the paper for more.