The Case Against the Charitable Deduction
Freshman representative Alexandria Ocasio-Cortez (D-NY) made headlines in the days after she took office by calling for a top marginal tax rate of up to 70 percent on income over $10 million. While some economists have disputed the merits of this proposal, as it might hurt the economy by reducing innovation while not raising much tax revenue, reforming the tax code is an evergreen topic in Congress, and justifiably so. The Tax Cuts and Jobs Act made some important changes in 2017, but the tax code is by no means perfect right now.
Instead of raising tax rates on high-income earners, a smarter way for progressives to raise taxes on higher-income earners would be to eliminate itemized deductions: tax breaks that allow primarily upper-middle and upper-income earners to write off various expenses. These deductions distort economic decisionmaking and can even enable corruption. One of these deductions is the deduction for charitable contributions, and while it might sound callous to end such a tax break, it predominantly benefits high-income taxpayers, does not significantly increase charitable giving, and even raises prescription drug prices.
The charitable contributions deduction benefits higher-income earners in several ways. For one, it’s an itemized deduction, and itemized deductions primarily benefit wealthier filers, while lower-income taxpayers tend to choose the standard deduction. As such, even though middle- and lower-income people donate a larger share of their income to charity, above-average income earners benefit more. In 2010, 65 percent of the total amount of charitable deductions were claimed by households earning more than $100,000, and in New York state this year, half of all the tax dollars were deducted by the top 0.5 percent of tax filers, who earned $1 million or more.
Additionally, how much the deduction increases charitable giving is in doubt. Thanks to the Tax Cuts and Jobs Act’s curbing of the mortgage interest and state and local tax deductions, along with its doubling of the standard deduction, many fewer taxpayers will itemize. As such, the number of people taking advantage of the charitable deduction is expected to fall from 37 million to 16 million. Nonetheless, charitable contributions have decreased only marginally: USA Today estimated that charitable contributions will fall from $410 billion in 2017 to roughly $397 billion in 2018, which is still higher than the $390 billion in total contributions in 2016. The economic literature has not reached a consensus on how responsive potential donors are to tax incentives. Furthermore, charitable giving tracks closely with the strength of the economy, so pairing curbing the charitable deduction with pro-growth policy elsewhere could mitigate negative impacts on giving.
Lastly, the charitable deduction has been widely exploited by pharmaceutical companies to keep drug prices high and enrich themselves. As The Washington Post reported last April, drug companies donate to independent charities that help fund lower-income patients’ drug co-pays and insurance premiums. However, in the process, the charities choose plans with extremely favorable reimbursement rates for drug companies, allowing these deductible charitable contributions to function as kickbacks. Notably, pharmaceutical companies are responsible for almost twenty percent of all corporate charitable donations in the United States.
Eliminating the charitable deduction altogether would raise roughly $42 billion dollars a year in tax revenue annually relative to current law. However, there are several alternative paths to reforming it. In the CBO’s latest Options for Reducing the Deficit report, they proposed two strategies: either to only allow taxpayers to deduct cash donations, or to only allow taxpayers to deduct charitable contributions in excess of two percent of their adjusted gross income. Several years ago, The Committee for a Responsible Federal Budget proposed several more options, such as making donations to certain institutions, such as nonprofit hospitals or universities, no longer deductible, or eliminating the deduction for corporations.
The case of the charitable deduction should send a message to progressives concerned about income inequality and interested in raising taxes on the rich. Under the current tax code, there are plenty of deductions and other tax breaks that one could go after well before ever raising the top marginal tax rate.