Charitable Donations

As appraisers our practice and derived income can be directly connected to and influenced by tax laws, such as the estate tax rate and the exemptions allowed for charitable donations.  At the end of 2012 several areas of current tax legislation and spending changes will be reviewed, some are even calling this period tax Armageddon and a fiscal cliff.  This fiscal cliff includes the expiration of Bush tax cuts, estate tax exemptions, spending cuts by the federal government and very possibly the re-examination of charitable donation deductions for high net worth individuals.  These tax law changes should be something appraisers follow, as the impact to our appraisal practice could be significant in terms of both income and who we market our services to.

The Economist recently published a very good look at Charitable donations, mainly in the UK and the US.  It also looks at charitable donations and tax breaks from a historical perspective and analysis the benefits or lack thereof of the deductions.

A good article for appraisers in understanding what very well could be a debate on tax legislation at the end of the year.

The Economist reports

A more promising line of defence for the charities is to view the tax break as a form of public expenditure that can be justified on the basis that it secures benefits for society that are worth more than the money which the state forgoes in taxes. For this argument to work, one needs to be convinced that tax breaks actually increase charitable giving. The headline giving numbers provide some support for this.

America has the most generous tax incentives for charity, and has the highest giving as a proportion of GDP, at 1.67%, according to a rare comparative study by Britain’s Charities Aid Foundation. Britain’s tax breaks for charity are the next-most-generous, and it had the second-highest share of charity to GDP, 0.73%, followed by Australia, 0.69%, which also has significant tax breaks. By contrast, the relatively weakly incentivised Germans give only 0.22% of GDP. The correlation is not perfect, though; despite their generous tax breaks, the French give just 0.14% of GDP.

Within countries one can look at changes in the “tax price”—the cost of a donation to the donor—for an indication of the effects of tax policies. If a taxpayer faces a marginal tax rate of, say, 28%, an extra dollar given to charity reduces the tax bill by 28 cents: the tax price is thus 72 cents. For a higher-rate taxpayer, say one paying a marginal tax rate of 50%, the tax price falls to 50 cents.

At first glance it would appear that the tax price is irrelevant. Dropping marginal tax rates on the wealthy in America has meant that the tax-price of donation there has soared over the past decades (see chart). But the rate of charitable giving, too, has increased. This seems to be because wealth matters too. As America’s rich have become much wealthier, they have given more to charity even though the cost of doing so has risen. Surveys suggest that tax rules affect the size and timing of gifts, but not the initial decision to give, which depends largely on being moved by the cause or being asked directly to support it.

The idea that growing wealth offsets high tax prices fits with evidence from a biannual survey of charitable donors by Bank of America and the Center on Philanthropy at the University of Indiana. In the 2007 survey 7% of high-net-worth families said they would “dramatically decrease” their giving, and a further 39.6% would “somewhat decrease” their giving, if changes in rules on exemption put up the tax price of their donations. Feeling less flush after the financial crisis, in 2009 the numbers had risen to 18.7% and 48.3% (the 2011 figures are due shortly).

Economists have been trying to work out how, other things being equal, changes in the tax price will affect behaviour. In the 1970s, early econometric studies by Martin Feldstein of Harvard, among others, suggested that the “tax-price elasticity” was more than one—that is, if the tax price were cut by 10%, giving would increase by more than 10%. If you assume that the public benefits more or less equally from charitable spending and taxable spending, that sounds like a good deal.

However, as these studies have become more sophisticated, the consensus estimate of the tax-price elasticity has diminished to significantly less than one. This shift matters: at less than one, an additional dollar in incentives for giving generates less than a dollar’s worth of donation. In such a situation charities need to produce more bang for the buck than state spending to justify their perks.

Source: The Economist