A 100% tax on charity

Posted by Marc Hodak on March 25, 2009 under Unintended consequences | Be the First to Comment

Obama’s new tax bill reduces the amount that the ‘wealthy’ (any couple making over $250K) can deduct for charitable contributions.  The intent is, in effect, to net the government more money at the expense of wealthy donors.  The predictable effect will be that each extra dollar the government gets will more or less come directly from the charities, leaving the putative donors with the same after-tax wealth.  Martin Feldstein does the math.

A substantial body of economic research shows that, on average, each 10 percent reduction in the cost of giving raises the amount that a person gives by about 10 percent…

Suppose someone would give $10,000 to a university if that amount were deductible at 35 percent. That deduction would reduce the individual’s tax bill by $3,500. Limiting the deduction to 28 percent would lower the individual’s tax saving on a $10,000 gift to $2,800.

This is where things get interesting: If the 10 percent increase in the cost of giving caused the person to reduce his gift by 10 percent, to $9,000, his tax savings would be 28 percent of $9,000, or $2,520. The government’s revenue loss would be reduced by $980 (from $3,500 to $2,520). The person’s gift to the university would be reduced by $1,000, almost the same amount. Since this high-income person would pay $980 more in taxes but give away $1,000 less, he would end up with an extra $20 for personal consumption.

In other words, the $980 hit that the government is expecting the wealthy taxpayer to take is likely to be taken entirely by a hospital, church, or school.  And that, Mr. Obama, is a lesson in tax incidence.

HT:  Greg Mankiw