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Tuesday, March 23, 2010

Charitable Contributions: The Itemized Deduction Cap and Other FY2011 Budget Options

Jane G. Gravelle
Senior Specialist in Economic Policy

Donald J. Marples
Specialist in Public Finance

The Administration's 2010 and 2011 budget outlines contain a proposal to cap the value of itemized deductions at 28%, for high-income taxpayers. In the 2010 proposal, the expected revenue was dedicated to addressing health care issues; as other sources are expected to finance health care, the proposal is now part of the increased taxes on upper income taxpayers. This proposal has generated considerable concern about its potential negative effect on charitable contributions. This concern has been heightened because charities are having difficulties in the current economic climate. The proposed tax change, however, would not go into effect until 2011 and thus the change could actually increase near-term contributions. Thus, it is the longer-term, or permanent, effect on giving that is the effect considered in this analysis. The analysis also considers the effects of other income tax changes and of the estate tax. 

The estimated effects of the cap and other elements of the budget package depend on whether the proposals are compared with the current tax rates of 33% and 35% or the rates scheduled for 2011, 36% and 39.6%. Compared with current rules, estimated effects are between one-half a percent and 1% decline in charitable giving, depending on whether the effects of capital gains tax rates on gifts of appreciated property are included. When compared with tax rate provisions in 2011, charitable deductions are estimated to fall by about 1.5% if only the cap is considered, but if income effects from the entire budget package are included contributions actually rise 2.5%. The relatively modest effects of the proposal arise because (1) the effect of caps on the subsidy value is limited, (2) only a fraction (about 16%) of charitable giving is affected, and (3) because evidence suggests that behavioral responses to changes in subsidies are relatively small. 

Different charities will be affected differently because the giving patterns of higher-income individuals differ from the average. Estimates show smaller reductions or larger increases for religious or combined charities, or charities directed at meeting basic needs, whereas the proposal is more likely to have negative effects for charities serving the health sector, and to a lesser extent art and education charities. Overall, contributions that benefit the poor will be less likely to fall or more likely to rise than the average contribution because the charitable purposes more favored by higher-income contributors are less likely to direct benefits to low-income recipients. 

Estate tax changes would also affect charitable giving. The budget outlines hold the current 2009 estate tax rules constant. Allowing the estate tax to lapse in 2010, as would the current rules, could lead to reductions in charitable giving of around 4%. Returning to the higher estate tax rates currently scheduled for 2011 could increase charitable giving, by about 1%, while adopting the FY2010 Senate Budget Resolution provision could reduce charitable contributions by about 1%. Although a smaller share of charitable contributions are affected by the estate tax, the changes in subsidy value are much larger if the estate tax is repealed, and the estimated behavioral response is greater. The immediate effects on contributions and the distributional effects of changes are, however, uncertain. Over half of bequests involve gifts to foundations, which finance a variety of charitable objectives and provide benefits with a considerable delay. 

Revenue from the cap on itemized deductions is currently directed at increasing revenues to finance other programs. If the cap is rejected either overall, or for charitable contributions, other revenue sources found, or the debt increased. Alternative revenue options include, among others, implementing a floor under charitable deductions and increases in tax rates on high-income taxpayers

Date of Report: March 18, 2010
Number of Pages: 35
Order Number: R40518
Price: $29.95

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