Tax Reform Options: Incentives for Charitable Giving

Comments for the Record

United States Senate Committee on Finance

Tax Reform Options: Incentives for Charitable Giving

Tuesday, October 18, 2011, 10:00 AM

215 Dirksen Senate Office Building

By Michael Bindner

Center for Fiscal Equity

Chairman Baucus and Ranking Member Hatch, thank you for the opportunity to address this topics. In our comments, we will describe how our tax plan relates to this issue, discussing the incentives for charitable contributions in the income tax generally and how contributions to charity might work with our proposal for a VAT-like Net Business Receipts Tax (NBRT). This proposal is not the same as the charitable tax credit proposed by Len Burman and by the Bipartisan Policy Center for a charitable tax credit included as part of automatic income tax filing, although conceivable that feature could be included as part of the NBRT..

As you know, the Center for Fiscal Equity has a four part proposal for long term tax and health care reform. The key elements are

• a Value Added Tax (VAT) that everyone pays, except exporters,
• a VAT-like Net Business Receipts Tax (NBRT) that is paid by employers but, because it has offsets for providing health care, education benefits and family support, does not show up on the receipt and is not avoidable at the border,
• a payroll tax to for Old Age and Survivors Insurance (OASI) (unless, of course, we move from an income based contribution to an equal contribution for all seniors), and
• an income and inheritance surtax on high income individuals so that in the short term they are not paying less of a tax burden because they are more likely to save than spend – and thus avoid the VAT and indirect payment of the NBRT.

The amount the income tax impacts charity is inversely proportional to the tax rate. Higher marginal tax rates provide more an incentive to giving than lower marginal tax rates, which is why since the 2001 and 2003 tax cuts, charitable giving is down while need is up because dividend rate cuts make labor savings productivity increases more attractive, therefore increasing the need for charitable services.

Many opponents of governmental charitable action maintain that lower tax rates leave more money for private charitable donations and work toward job creation. Recent experience shows that this is not the case. One of the saddest examples of this was last thanksgiving, where it took media reports of empty food banks with no turkeys to move the public to donate. If conservative beliefs on how low taxes lead to jobs and charitable giving were true, food pantries would have been overflowing, the coffers of charitable institutions would have been full and there would have been no need for such services because everyone would be employed, given how low taxation is on a historic basis.

There is also an allocation problem with private donations. Donor sovereignty does not always put such donations where most agree they do the most good. Food banks go empty while The Heritage Foundation, The Tax Policy Center and efforts by the Bill and Melinda Gates Foundation and Warren Buffett to fund birth control in developing nations (which amounts to population eugenics) get funded. I challenge conservative members to justify that result to their pro-life constituents when making the argument that funders know better than voters.

That being said, our plan does include provisions for a charitable deduction against the income surtax. Because the surtax is graduated with rates ranging from 4% to 28%, the incentive to give to charity will be low for lower income heirs and income earners and higher for those with higher incomes, whose donations will make more of an impact.

Corporate giving will be impacted by our proposal, as the Corporate Income Tax will be replaced by a VAT-like Net Business Receipts Tax (NBRT). We suggest that charitable contributions be limited to a series of credits rather than an open ended deduction that can be maximized to give according to donor preference. Unlike a straight up-VAT, however, some form of giving is still possible. Indeed, providing a vehicle for tax expenditures now distributed through the corporate income tax and personal income tax is the entire reason for proposing both a VAT (which provides tax visibility) and an NBRT.

The expanded refundable Child Tax Credit will replace much of the need for private charity, as it will be paid both to workers and paid participants in adult literacy and education programs, with payments at the same levels. Offsetting the credit with ending the child tax exemption, mortgage interest deduction and property tax deduction allows a federal credit of $520 per month per child. If this is matched, even in part, by a state level credit, the question of the need for private charity to feed people will moot.

Assistance at this level, especially if matched by state governments may very well trigger another baby boom, especially since adding children will add the additional income now added by buying a bigger house. Such a baby boom is the only real long term solution to the demographic problems facing Social Security, Medicare and Medicaid, which are more demographic than fiscal. Fixing that problem in the right way definitely adds value to tax reform.

This is not to say that private charitable organizations can be dispensed with. The experience of using Catholic Charities Family Services in lieu of public adoption services, although not without controversy regarding who can adopt, shows the promise of how charitable organizations can outperform government. This would likely also be true in the area of adult education.

One feature of the NBRT is that it allows employers (either on their own choice or responding to the preferences of their employees) to designate alternative providers without forcing qualified providers to compete in a public procurement process – although maintaining the requirement of accreditation and review is still essential. This is a feature that is impossible with the FairTax or a VAT alone. This feature can also be used, mostly at the local level, to fund public and private charter schools, including religious charter schools, although some jurisdictions could require that such schools allow union organization as a condition of participation (a compromise which would likely reverse resistance the National Education Association).

To extract health care cost savings under the NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit, provided that services are at least as generous as the current programs. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but not so much that the free market is destroyed. This could also allow senior citizens in need of full time care to avoid selling off all of their property and becoming objects of public charity in order to get such care.

Enacting the NBRT is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.

Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.

In testimony before the Senate Budget Committee, Lawrence B. Lindsey explored the possibility of including high income taxation as a component of a Net Business Receipts Tax. The tax form could have a line on it to report income to highly paid employees and investors and pay surtaxes on that income.

The Center for Fiscal Equity considered and rejected a similar option in a plan submitted to President Bush’s Tax Reform Task Force, largely because you could not guarantee that the right people pay taxes. If only large dividend payments are reported, then diversified investment income might be under-taxed, as would employment income from individuals with high investment income. Under collection could, of course, be overcome by forcing high income individuals to disclose their income to their employers and investment sources – however this may make some inheritors unemployable if the employer is in charge of paying a higher tax rate. For the sake of privacy, it is preferable to leave filing responsibilities with high income individuals.

Finally, keeping a separate income and inheritance surtax also allows the maintenance of direct charitable giving in the tax code, as well as the ESOP exclusion which facilitates the tax-free sale of companies to their employees.

Thank you for the opportunity to address the committee. We are, of course, available for direct testimony or to answer questions by members and staff.