Options for Changing the Tax Treatment of Charitable Giving

May 24, 2011

The deductibility of charitable donations has been a feature of the U.S. individual income tax almost as long as the modern income tax has been in existence. Although the deduction encourages charitable giving, like other forms of preferential tax treatment, it results in loss revenue to the federal government. At current levels of charitable giving, the cost of that deduction—measured as the additional revenues that could be collected if the deduction was eliminated—will total about $230 billion between 2010 and 2014, according to the Joint Committee on Taxation.

At the request of the House Budget Committee, CBO released a study today entitled Options for Changing the Tax Treatment of Charitable Giving. The study examines patterns of individual charitable giving and analyzes how options for changing the tax treatment of such giving might affect the overall amount of donations, the costs to the federal government, and the distribution of tax benefits among different income groups.

CBO’s Analysis

Under current law, taxpayers who itemize deductions may deduct the amount they donate to charities from their adjusted gross income (AGI) when determining how much they owe in federal income taxes. CBO looked at 11 options for altering that approach to the treatment of charitable giving, which can be grouped into four categories:

  • Retaining the current deduction for itemizers but adding a floor—a minimum amount that a person’s charitable giving would have to exceed to qualify for preferential tax treatment.
  • Allowing all taxpayers, not just those who itemize, to claim the deduction, with or without a floor.
  • Replacing the deduction with a nonrefundable credit for all taxpayers, equal to 25 percent of a taxpayer’s charitable donations, with or without a floor. 
  • Replacing the deduction with a nonrefundable credit for all taxpayers, equal to 15 percent of a taxpayer’s charitable donations, with or without a floor.

For each of the four categories, CBO analyzed two potential floors: a fixed dollar amount ($500 for single taxpayers and $1,000 for couples filing a joint return) and a percentage of income (2 percent of AGI). Only contributions in excess of the floor would be deductible or eligible for a credit.

General Effects of Options for Changing the Charitable Deduction

CBO estimated what the budgetary impact of the policy options would have been in 2006, the most recent year for which the Internal Revenue Service’s public-use sample of individual income tax returns is available. In that year, contributions totaled $203 billion and the tax subsidy—the cost in forgone revenues to the federal government—was $40.9 billion.  As summarized in the following table CBO estimates that:

  • Adding a contribution floor to any of the approaches listed above would reduce both the tax subsidy and the total amount donated to charity, relative to the same option without a floor. In each case that CBO examined, the reduction in the subsidy—and thus the increase in revenues—would exceed the reduction in charitable contributions, whether measured in dollars or as a percentage change. The reason is that introducing a floor would continue to provide a tax incentive for additional giving above the floor while reducing the tax subsidy for donations that people might have made even without a tax incentive.
  • Allowing all taxpayers to claim a deduction for charitable giving would have increased donations in 2006 by an estimated $2.0 billion (or 1 percent) and increased the total tax subsidy in that year by $5.2 billion (or 13 percent).
  • Combining a deduction for all taxpayers with a floor, however, could both increase donations and decrease the tax subsidy. For example, such a deduction combined with a fixed dollar floor of $500/$1,000 would have increased donations by $800 million in 2006 and decreased the tax subsidy by $2.5 billion.
  • Replacing the current deduction with a 25 percent tax credit would increase donations and also increase the tax subsidy.

This analysis estimates the cost of the tax preference for charitable donations by focusing on the change in revenues directly attributable to the amount of charitable giving. That approach differs from the type of revenue estimates that are the responsibility of the staff of the Joint Committee on Taxation (JCT). JCT’s estimates would reflect many of the ways in which taxpayers might alter their behavior in response to the existence of the tax preference, such as changing the timing of donations between years and changing their tax compliance. The measure that CBO used does not reflect all of the behavioral assumptions that would be included in a revenue estimate; it accounts only for changes in the amount of charitable giving and any changes in the extent to which taxpayers itemize their deductions that would occur if the standard deduction was larger than a taxpayer’s noncharitable itemized deductions.

The results of CBO’s policy simulations are meant to highlight the general effects of the various approaches. The exact size of those effects, however, would depend on the specific parameters of a policy—such as the level of the floor or the amount of the credit—as well as on the extent to which taxpayers would change the amount of their charitable giving in response to a change in the tax subsidy.

Effects on Various Income Groups

Changing the tax treatment of charitable contributions would have differing effects on taxpayers at different points on the income scale. Adding a contribution floor to the current deduction for itemizers would reduce tax subsidies for all income groups, but for high-income taxpayers, the size of the reduction would vary significantly depending on the type of floor used. For example, a floor equal to 2 percent of AGI would reduce subsidies by a greater amount than a fixed-dollar floor of $500/$1,000 in 2006.

Making the deduction for charitable contributions available to non-itemizers would benefit lower- and middle-income taxpayers, who tend not to itemize deductions because their deductible expenses (such as mortgage interest and state and local taxes, as well as charitable donations) are not large enough to exceed the standard deduction. Those groups would benefit even more if the current deduction—which tends to help higher-income taxpayers more because they face higher tax rates—was replaced with a nonrefundable credit that gave all income groups the same tax incentives for giving.

This study was prepared by Athiphat Muthitacharoen of CBO’s Tax Analysis Division, and Seth Giertz, formerly of CBO.