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Proposal to Cap Deductions for High-Income Households Would Reduce Charitable Contributions by Only 1.9 Percent
Would Help to Finance Universal Health Coverage

The President’s 2010 budget proposes to limit the tax subsidy for deductible expenses of the most affluent Americans and to use the additional revenue to help finance national health reform, including universal coverage.  This proposal has been attacked on the grounds that it would lead to substantial reductions in charitable contributions and hit charities at a time when they face increased need and decreased contributions due to the recession.  Careful examination indicates that these criticisms are greatly exaggerated or wrong.

• New analysis by the Urban-Brookings Tax Policy Center shows that the proposal would affect only 1.4 percent of U.S. households — those in the top two tax brackets.  The other 98.6 percent of households would not be affected. [1] 
• Total charitable contributions would decline — but only by an estimated 1.9 percent.  Offsetting this decline, the proposal would help finance universal health coverage, which would greatly reduce burdens on the charitable sector to provide uncompensated health care to millions of Americans who lack insurance.  It would also make it easier for many small non-profit organizations to obtain health insurance for their own employees.
• The proposal would be unlikely to hit charities during the recession, because it would not take effect until nearly two years from now — January 2011 — by which time the economy is expected to be recovering.  If the economy is still weak at that time, Congress and the President almost certainly will delay implementing the proposal.  In fact, under those circumstances, it would be difficult politically for them not to do so.

 What the Proposal Is

Currently, middle-income Americans receive an individual income tax subsidy equal to 10 cents or 15 cents for each dollar of their deductible expenses (if they itemize deductions), while affluent Americans get a subsidy of 35 cents for each dollar of deductible expenses.  The Administration’s proposal would cap the subsidy at 28 cents on the dollar for those with incomes over $250,000 — the same rate at which those expenses could be deducted during the Reagan years, when the top tax rates were lower.  As a result, the incentive to incur those expenses would be the same as under President Reagan. 

Effect of Proposal on Total Charitable Contributions

The proposal would lead to some decline in charitable giving.  That reduction would be quite small, however, for several reasons.

First, a substantial portion of charitable giving derives from foundations, estates, and corporations and from individuals who do not itemize their contributions on their tax returns.  Itemized contributions represent only 62 percent of total charitable giving. [2]

Second, the proposal would affect only the 1.4 percent of tax filing units that are in the top two income tax brackets.  Tax Policy Center data indicate that these taxpayers account for only 28 percent of the charitable contributions that are reported as itemized deductions. [3]   Thus, only about 17 percent of total charitable giving would be affected.

Reducing the tax subsidy for charitable giving increases the after-tax price of a dollar of contributions.  Someone who is now in the 35-percent federal income tax bracket and lives in a state with a top income tax rate of 6 percent pays 59 cents after taxes for each dollar contributed to a tax-exempt charitable organization.  Under the proposal, which would limit the federal deduction to 28 percent, that person would face an after-tax cost of 66 cents — an increase in cost of 12 percent.  (The increase in the cost of giving would be 8 percent for those in the 33-percent income tax bracket.)  Based on research on the effect of tax incentives on charitable giving, this change would be expected to reduce total charitable giving in the U.S. by about 1.9 percent, or $6 billion.[4]  (The technical appendix explains the calculations.)

Other Budget Proposals Benefit Charitable Sector

The Obama Administration’s health reform proposal aims to provide health coverage to most or all of the 45 million Americans who are now uninsured.  Currently, people without health insurance receive some free care from hospital emergency rooms, neighborhood health clinics, and other charitable organizations.  Health reform will greatly reduce the burden on non-profit organizations to provide free health care, thereby offsetting to a significant extent the overall drop in contributions.

Finally, the Administration’s budget also proposes to make permanent the estate tax as it stands in 2009, rather than to allow the estate tax to be repealed or shrink further, as would occur under a number of other proposals that have been advanced on Capitol Hill and in political campaigns.  The estate tax operates as a powerful incentive for charitable giving.  Giving by estates would be significantly higher under the Obama proposal than under competing proposals that would further curtail the tax.

The projected loss of about 1.9 percent of total charitable contributions from the cap on itemized deductions should thus be weighed against the beneficial effects on the charitable sector of both universal health coverage and maintaining the current estate tax.  Overall, the effect of the budget proposals on charities is probably a very small negative at worst — and quite likely a net positive.

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