Taking a Closer Look at the Charitable Deduction

Though recent discussion about "spending in the tax code" has brought fresh attention to tax expenditures, much of the discussion has been about how to deal with them comprehensively. For example, CRFB President Maya Macguineas recently put out a plan with Martin Feldstein and Daniel Feenberg to limit how much an individual could collect in tax expenditures, and the Fiscal Commission proposed a Zero Plan to wipe out most of the tax expenditures and use a portion of the money for rate reduction. However, it is also useful to break down some of the bigger tax breaks and examine them individually. Fortunately, CBO provides us with a new report outlining options for changing the charitable deduction.

The charitable deduction, for donations to qualified nonprofit organizations, is one of the larger tax expenditures in our tax code -- OMB estimates that it will cost over $300 billion in the next five years. And although the goal of promoting charitable giving is certainly a noble one, a number of policies have the potential to reduce the cost of the deduction while continuing to promote charitable giving.

CBO's options break down into four categories:

  • Adding a floor to the current deduction
  • Making the deduction available to taxpayers who don't itemize
  • Replacing the deduction with a 25 percent non-refundable credit
  • Replacing the deduction with a 15 percent non-refundable credit

Each of the latter three options come in three variations: no floor, a $500 floor ($1,000 for families), or a two percent of income floor. The floor would make it so the tax benefit would not be available on the first dollar of charitable giving, and instead would only be available on giving above that floor (for example, an individual who gives $600 under the 25 percent credit/$500 floor scenario would recieve a tax subsidy of $25 -- 25 percent of their last $100). Many economists see a floor as a very efficient way to limit the subsidy, since it would be unlikely to impact incentives on the margins but could still limit the "windfall subsidy" for charitable giving which would have been done anyway.

For each option, CBO estimates the savings/costs and the impact on charitable giving in 2006. The budget impact ranges from increasing the 2006 cost by $7 billion (25 percent credit, no floor) to reducing the cost by $25 billion (15 percent credit, two percent floor).

We've attempted to roughly re-estimate those savings if the policy were to be in effect over the next decade.

Charitable Deduction Options
Option 2012-2021 Savings (billions)
Percent Change in Subsidy Percent Change in Giving
$500/$1,000 Floor $80 -13.5% -0.2%
Two Percent of AGI Floor $220 -38.5% -1.5%
Extend Deduction to All Filers -$70 12.8% 1.0%
Extend Deduction With $500/$1000 Floor $30 -6.1% 0.4%
Extend Deduction with Two Percent Floor $180 -32.1% -0.9%
Convert to 25 Percent Credit -$100 17.4% 1.3%
25 Percent Credit With $500/$1000 Floor $30 -5.8% 0.7%
25 Percent Credit With Two Percent Floor $170 -29.2% -0.5%
Convert to 15 Percent Credit $190 -32.6% -3.9%
15 Percent Credit With $500/$1000 Floor $270 -46.5% -4.2%
15 Percent Credit With Two Percent Floor $340 -60.1% -4.9%

CBO's numbers bear out the fact that limiting the charitable deduction, especially through the use of a floor, would have a very limited effect on giving compared to the savings. For example, enacting a 25 percent credit with a 2 percent of income floor would reduce charitable giving by $1 billion but would save $12 billion. Note that two of the deficit-reducing options, both involving the $500/$1,000 floor, would actually increase charitable giving. And even for the options that reduce charitable giving, the government could, for example, directly spend on causes that are typically supported by charitable organizations--offsetting, and then some, the decrease in donations--and still have money left over to reduce the deficit.

Two of the major bipartisan plans out right now, the Bowles-Simpson Fiscal Commission plan and the Domenici-Rivin Debt Reduction Task Force plan, would both make changes to the charitable deduction along these lines. The Fiscal Commission's illustrative tax plan would replace the deduction with a 12 percent credit with a floor at two percent of AGI, for savings similar to the most stringent option. The Domenici-Rivlin tax reform plan would simply replace the deduction with a 15 percent refundable credit with no floor. Both of these options would limit the subsidy for high earners and make it available to non-itemizers while significantly reducing the expenditure's cost.

In addition, our Let's Get Specific paper on tax expenditures recommends instituting a floor at two percent of AGI for the current deduction.

The charitable deduction is just one of many tax expenditures that need to be scrutinized in any serious budget debate. Many of these tax breaks are poorly targeted, regressive, and costly. They must be on the table as part of any tax reform or deficit reduction discussion.