Panel Paper: Evaluating Options for Reforming the Charitable Income Tax Deduction

Thursday, November 8, 2012 : 10:35 AM
Jefferson (Sheraton Baltimore City Center Hotel)

*Names in bold indicate Presenter

Joseph Rosenberg, Urban Institute and Joseph Cordes, George Washington University

The income tax deduction for charitable contributions will reduce federal tax revenues by nearly $40 billion this year, according to the most recent estimates from the Joint Committee on Taxation. The combination of graduated income tax rates, deductibility of contributions, and the many other tax rules governing charitable gifts produces a system where the tax incentive varies widely by individual and type of gift, with higher income taxpayers receiving the largest incentives.

Meanwhile, ongoing debates on tax and budget reform at the federal level have focused renewed scrutiny on tax expenditures, including the charitable deduction. President Obama’s National Commission on Fiscal Responsibility and Reform suggested replacing the deduction with a 12 percent nonrefundable tax credit for contributions in excess of 2 percent of income. The Bipartisan Policy Center’s Debt Reduction Task Force’s plan called for a matching grant equivalent to a 15 percent refundable credit. A proposal that would limit the tax benefit of the charitable deduction to no more than 28 percent has been present in each of the President’s annual budgets. Understanding the impact of various reform options on charitable giving and the services that nonprofits provide is crucial to assessing the merit of the proposals from a broader public perspective.

This paper will assess various options for reforming the current income tax deduction. Using the Urban-Brookings Tax Policy Center’s microsimulation tax model, we will estimate how various reforms would affect tax incentives to donate and the likely impact on the amount of individual charitable giving. Building on the work of Cordes (2011), we will use data from nonprofit tax returns (Form 990) and survey data on giving patterns to estimate the impact of these changes on the financial resources of nonprofits. Reform options include retaining the current deduction but capping the rate at which deductions can be taken; retaining the current deduction but limiting it to deductions in excess of a minimum floor; combining a limit on the deduction rate with a deduction floor; and replacing the deduction with a flat-rate tax credit with or without a deduction floor.