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Tax History: Charity Deductions Are for the Rich — and That Was Always the Plan

Posted on Sep. 16, 2019

In 1917 Congress created an income tax deduction for charitable gifts. The provision was itself a gift — to the nation’s wealthiest philanthropists. And in the century since, it has remained a rich person’s benefit, subsidizing charitable giving by a relatively small slice of the taxpaying public.

That’s the takeaway of a new article on the history of the charitable deduction, published last month by the Business History Review. In “Founders’ Fortunes and Philanthropy: A History of the U.S. Charitable-Contribution Deduction,” economist Nicolas J. Duquette traces the deduction’s creation and evolution, emphasizing its focus on the nation’s economic elite. “The philanthropy of the very rich has always been the object of the tax deduction, and the modern conception of it as an incentive for giving more broadly is a new element of our discourse,” Duquette writes.

What’s less new, however, are other conceptions that helped spur the creation of the deduction and shaped its development over the past century. In particular, the deduction has drawn strength from a durable anti-government strain in American political culture that often prefers private to public forms of social welfare.

“We trust one another, and not just the government, to make important decisions and to take action,” observed Yale economist Robert J. Shiller in a 2012 New York Times article. “We don’t rely on government to set all of our goals — even our social goals, our wishes for the nation’s future. The essential question we all must answer is how we can achieve the good society.”

Obvious but Necessary

To tax experts, Duquette’s distributional point about the charitable deduction may seem obvious, given (1) the percentage of people who itemize and (2) the effect of a progressive rate structure on the value of a deduction. But it’s not obvious — or at least not generally acknowledged — in much of the public debate surrounding the charity deduction.

Many champions of the deduction tend to skip lightly over the distribution of its benefits. In the run-up to the Tax Cuts and Jobs Act, for instance, one defender of the deduction complained that an increased standard deduction would eliminate giving incentives for average taxpayers. “The vast majority of us would be taxed on the money we give away — for everything from arts to zoos, including houses of worship, disaster relief, human services, education, health care, veterans and more,” wrote Tim Delaney in The Hill.

Of course, most taxpayers were already being taxed on those gifts, because only about 30 percent of taxpayers were itemizing before the TCJA. In the wake of its enactment, that number has fallen to 13 percent, according to the Urban-Brookings Tax Policy Center. That’s a big drop, but it doesn’t change that the deduction was narrowly targeted to begin with. Indeed, as Duquette points out, the deduction was conceived to function as a narrow subsidy for wealthy philanthropists.

Wartime Origins

Congress created the charity deduction in 1917. But lawmakers weren’t trying to encourage new giving in the spirit of shared wartime sacrifice. Rather, they were seeking to protect charitable institutions from the ravages of the nation’s new income tax. “Lawmakers saw philanthropists as a source of social capital that should be protected from the new tax on high incomes, lest the government find itself having to pay for programs philanthropy had previously funded voluntarily, out of the donors’ own pockets,” Duquette writes.

Indeed, philanthropy helped inspire the deduction, not the other way around. Congress created the deduction “not to encourage the wealthy to give their fortunes away (which the most influential and richest men were already doing) but to not discourage their continued giving in light of a larger tax bill,” Duquette points out.

Sen. Henry French Hollis explained the problem to his colleagues:

Usually people contribute to charities and educational objects out of their surplus. After they have done everything else they want to do, after they have educated their children and traveled and spent their money on everything they really want or think they want, then, if they have something left over, they will contribute it to a college or to the Red Cross or for some scientific purposes. Now, when war comes . . . that will be the first place where wealthy men will be tempted to economize, namely, in donations to charity.

Wartime taxes, by diminishing the rich person’s “surplus,” would necessarily crimp the charitable impulse. “There is a necessary social effect to this taxation of great incomes,” The New York Times observed in an editorial. “It diminishes or dries up the springs of philanthropic eleemosynary and educational life.”

Editorial writers at The Washington Post were even more explicit about the implications for public finance. “If the government takes all or nearly all of one’s disposable income or surplus income, it must undertake the responsibility for spending it, and it must then support all those works of charity and mercy and all the educational and religious works which in this country have heretofore been supported by private benevolence,” the editors wrote. (Prior analysis: Tax Notes, Dec. 17, 2012, p. 1276.)

Lawmakers enacted the charitable deduction as a partial remedy for this problem. It was a way to preserve the privatized welfare state.

That view of the charity deduction proved durable, existing largely unchallenged until the 1970s, Duquette contends. Only after the concept of tax expenditures gained traction did lawmakers stop talking about what private philanthropy might save the fisc (in the form of lower spending) and start talking about what it might cost (in the form of lower revenue). Duquette attributes the conceptual shift to economist Martin Feldstein: “Instead of asking how much less the government needed to spend thanks to philanthropy, Feldstein asked how much the deduction cost the Treasury relative to the additional giving it induced.”

Feldstein’s reconceptualization of the charity deduction had precedent. As early as the 1930s, Treasury economists were suggesting that all tax provisions designed to encourage specific activities (or curb others) should be scrutinized carefully — and even evaluated as expenditures. (They made this argument most explicit in discussions of charitable exemptions, rather than donor deductions.)

Still, Duquette is right to identify a sea change in the late 1960s and early 1970s regarding the charity deduction. And in the 1980s, the champions of the deduction found themselves on the losing end of several key debates within the broader movement for tax reform.

Standard Deduction

It wasn’t the first time that tax reform — and tax simplification, in particular — changed the functioning of the charitable deduction. In 1944 Congress created the standard deduction. Charitable organizations opposed the move vigorously, insisting that it would slash contributions and endanger the future of countless worthy organizations.

Charities also complained that the change was unfair, effectively granting the tax benefits of charitable giving to people who made no gifts at all. “It is utterly unfair to give a profligate spendthrift who seldom gives a penny to charity the same credit and tax deduction as the devout widow or the conscientious contributor who gives a tithe or sacrificially gives 15 percent or more, in order to share with those who are less fortunate,” declared one charity lobbying group. (Prior analysis: Tax Notes, Mar. 31, 2014, p. 1394.)

The introduction of the standard deduction certainly made the charitable deduction less relevant to most taxpayers. In 1943, 75 percent of American households were eligible to take the deduction, and the remaining 25 percent didn’t file tax returns, Duquette points out. After lawmakers created the standard deduction, only 14 percent chose to itemize (oddly, a drop of almost the same size as the one that occurred after enactment of the TCJA).

Privatizing the Welfare State

When the charitable deduction first appeared, income taxes were an exclusive burden, focused narrowly on the rich. Deductions of any sort were therefore similarly narrow; the charitable deduction was no exception.

World War II changed that political and economic reality. When lawmakers dramatically increased the number of income tax payers, they also increased the political salience of deductions. For a brief moment, the American middle class had a direct stake in what might be deductible from taxable income. Almost immediately, however, the introduction of the standard deduction returned the charity deduction to its traditional, rather narrow role within the revenue system.

In terms of politics, however, the charitable deduction remained a high-profile issue. Its salience derived not simply from the political influence of itemizers, but also from the influence of charities that benefited from deductible donations. For decades, that combined influence effectively insulated the charitable deduction from serious challenge.

The drive for tax reform — and the rise of tax expenditure analysis — upset that political arrangement. So did the end of what C. Eugene Steuerle has called the “Era of Easy Finance”; as policymakers began to wrestle with chronic fiscal gaps, many hitherto sacrosanct tax provisions found themselves under scrutiny. Tight budgets and tax reform have been a bad combination for the charity deduction.

But one thing hasn’t changed much in all the decades since the charitable deduction first appeared: the support it draws from powerful American traditions of anti-statism. The deduction is deeply enmeshed with popular suspicion of governmental activism. Indeed, many of the lawmakers who have worked to diminish the deduction’s role in the tax system have nonetheless continued to venerate the social and political importance of privatized social welfare.

Like every tradition, anti-statism has been contested, often vigorously, by champions of an activist state. But it remains a potent force in shaping the politics of charitable giving. And while the charity deduction has taken its lumps in recent years, it seems likely that anti-statist inclinations will keep it on the agenda for years to come.

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