The Future of the Charitable Deduction The deduction for charitable contributions is among the oldest and most popular in the tax code. According to the Treasury, it reduces federal revenues by $54 billion, making it the fifth-largest tax expenditure. Whether or not it is curtailed to raise revenue for tax-rate reductions, there are growing concerns about the deduction and also about the mission and operations of some tax-exempt institutions. The charitable deduction was added to the tax code in 1917, when taxes were sharply raised to pay for World War I. The concern was that raising the top income tax rate to 67 percent from 15 percent would deprive rich people of the surplus from which they had been making charitable contributions. The New York Times was among those expressing concern about this. An Aug. 24, 1917, editorial said: "There is a necessary social effect to this taxation of great incomes. It diminishes or dries up the springs of philanthropic eleemosynary and educational life. The deduction for charitable contributions allowed the wealthy to continue making contributions from before-tax income. Although there was wide popular support for giving charitable contributions a tax break, there were those who questioned it. The historian Joseph Thorndike quotes a 1916 report by the Commission of Industrial Relations expressing concern that the wealthy would come to control the nonprofit world as they already controlled the profit-making world. As the report said: The dominion by the men in whose hands the final control of a large part of American industry rests is not limited to their employees, but is being rapidly extended to control the education and "social service" of the nation. This control is being extended largely through the creation of enormous privately managed funds for indefinite purposes, hereinafter designated "foundations," by the endowment of colleges and universities, by the creation of funds for the pensioning of teachers, by contributions to private charities, as well as through controlling or influencing the public press. This is still a problem today. As one can see in the table from Congress's Joint Committee on Taxation, the vast bulk of charitable gifts in dollar terms come from the wealthy, those making more than $200,000 a year. If the priorities of the wealthy were the same as those of the nonwealthy, this probably wouldn't matter too much. But they are not. As the following chart from a blog post by Catherine Rampell in The New York Times shows, those with moderate incomes are far more likely to contribute to churches and other religious organizations, while the wealthy give relatively little of their total contributions to such groups. Education, health and arts organizations are much more significant recipients of contributions by the wealthy than by the nonwealthy. Although those with low incomes are not less generous than the wealthy, the bulk of them either have no federal income tax liability or use the standard deduction and therefore cannot deduct their contributions. By contrast, the value of the charitable deduction rises with income because tax rates rise with income. For someone in the top bracket, the federal government provides a de facto subsidy of 40 percent. As I noted last week, Congressional leaders are committed to reducing the top tax rate, maintaining the same level of revenues and the existing progressivity of the tax code. This means that deductions that largely benefit the wealthy, like the one for charitable contributions, are likely to be on the table. Not surprisingly, charitable groups have been lobbying against any curtailment of their deduction for some time. It should be kept in mind, however, that if the top tax rate falls to 25 percent from 39.6 percent, as Representative Dave Camp of Michigan, the Republican chairman of the House Ways and Means Committee, says he hopes, this action alone will automatically reduce the value of the deduction by almost half. Instead of saving 40 cents in taxes for each dollar contributed, only 25 cents will be saved. Scholars are divided on the charitable deduction. Writing in The New York Times, Richard Thaler of the University of Chicago has said it needs to be rethought. He notes the unfairness of giving a large tax reward to the wealthy while giving nothing to those with modest incomes. Also writing in The Times, Robert J. Shiller of Yale says we shouldn't undermine the generosity of Americans, who give far more to charity than the citizens of any other country. He suggests expanding the deduction by making it available to those who don't have enough deductions to be able to itemize. One obvious compromise would be to convert the charitable deduction to a tax credit: some percentage of contributions could be subtracted directly from one's tax liability rather than from taxable income. This would equalize the tax reward across incomes and could be done in a way that raised net revenue to pay for rate reductions. Whether or not the charitable deduction is part of tax reform, Congress should take the opportunity to examine the operations of charitable organizations. Some have been criticized for being excessively political, contrary to law. There are also concerns about abuse by some managers of nonprofits, who pay themselves excessively while spending little on actual charity. On June 13, the Senate Finance Committee published an options paper for reforming the charitable deduction and abuses by tax-exempt organizations. While complete abolition of the charitable deduction is one option, it is one very unlikely to be adopted. The combined lobbying clout of the churches, universities, hospitals, art museums and other recipients of charitable contributions will see to that. The deduction for charity is also very popular with the public. A Dec. 11, 2012, McClatchy-Marist poll found 69 percent of voters opposed to ending it, with 28 percent in support.