February 27, 2009

Obama’s Budget Would Cut Charitable Deduction

By Mark Hrywna

Charitable giving could take a hit under President Barack Obama’s new federal budget – or it might not, depending on to whom you talk – or argue.

Unveiled on Feb. 26, the president’s proposed Fiscal Year 2010 budget, if passed by Congress, would reduce the deductibility of charitable contributions from 35 percent to 28 percent on households that earn more than $250,000 annually. It also calls for a return of the 39.6 percent tax bracket, which could affect charitable giving.

The budget sets “an ambitious agenda” for health care and the economy while underscoring the president’s pledge of fiscal responsibility, said Diana Aviv, president and CEO of Independent Sector, a Washington, D.C.-based nonprofit advocacy coalition. The change in charitable deductions, however, could be a disincentive to donors who might cap their gifts because of the new limit. “This could be a problem for many struggling nonprofits vital to our communities that are already facing a very difficult fundraising environment,” she said.

Research suggests that a 10-percent increase in the after-tax cost of donations cuts giving by 4 to 8 percent, according to Roberton Williams, senior fellow at The Urban Institute’s Tax Policy Center in Washington, D.C.

The proposed increase in the top tax rate from 35 percent to 39.6 percent widens the gap between the tax rate and the value of the charitable deduction, Williams said. The higher tax rate by itself would increase giving by lowering the after-tax cost of giving -- if the contribution is fully deductible at the full tax rate. Relative to that higher giving, however, the 28 percent limitation would raise the after-tax cost of giving more, he said.

One other factor is that the proposed changes lower a taxpayer’s after-tax income, making them feel poorer, which has an “income effect” that leads them to give even less, Williams said.

Tax incentives are a pretty motivating factor as gifts get larger, according to Michael Nilsen, senior director of public affairs for the Association of Fundraising Professionals (AFP). “Is the impact going to be hugely significant? I don’t know if the sky’s going to be falling but there will be some negative impact,” he said. Given the current health of the sector and workforce, with charities being asked to do more, Nilsen said, to limit the deduction “simply doesn’t make sense.”

Others in the sector are not convinced that the moves will hurt charitable giving. Research suggests that not all that high-income earners give is actually deducted, said Nancy Raybin, chair of Giving Institute.

About 3 percent of tax returns in 2006 (the most recent data available) had income of $200,000 or higher, which equates to approximately 3.4 million households, according to research conducted on behalf of Giving USA. Those returns claimed 42.5 percent of the total amount itemized that year.

A Bank of America study of high net-worth individuals in 2006 said that 53 percent said they would not change their charitable giving, or would even increase it, if the deduction for charitable gifts went to zero. “However, there is research that shows that people do change the amount that they claim in their giving when tax rates change. Higher tax rates mean more giving is itemized, everything else being equal,” said Giving USA Managing Editor Melissa Brown.

“It is likely that when tax rates are high, at least some people will work harder to keep track of their giving and find it more worthwhile to submit the information to accountants so it shows up on returns,” said Del Martin, chair of Giving USA Foundation. “It is also possible that some people, when asked to give, do determine some kind of cost-benefit analysis and look at the potential tax savings.”

The most important factor in how much people give is not always the tax situation but how committed they are to the purpose of the request. “The bottom line is that this is no time for panic in the nonprofit world,” both Martin and Raybin said. “Time and time again, it has been shown that when wealth is created, giving increases. If the president’s plan generates more wealth for Americans, then giving will go up.”