As Congress begins to address and discuss comprehensive taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform, the Committee on Ways and Means will hold a hearing to examine charitable contributions this week on Valentine’s Day. As the Committee assesses the benefits of the itemized tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. for charitable contributions, they also must closely evaluate the cost of allowing charities to enjoy preferential treatment by the tax code. Because of the itemized deductions, the cost of donating to charity is effectively lowered by an individual’s highest marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. . For example, if I face a marginal tax rate of 39.6%, my one dollar donation that is deducted from my taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. only costs me 60.4 cents because I avoid paying 39.6 cents in federal income taxes. Thus, the deduction actually costs the government 39.6 cents in lost revenue, but the charity receiving the donation gains one dollar in revenue. In essence, the tax code subsidizes charitable giving and creates an incentive for individuals to donate, but it is at the expense of reducing the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .
The individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. deduction for charitable donations has been part of the federal tax code for almost as long as the federal income tax. It was implemented as part of the Revenue Act of 1917. Deductions for charitable donations were expanded to estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. returns as part of the Revenue Act of 1918 and eventually extend to corporations in 1936. Under the Tax Revenue Act of 1969, the maximum deduction limitation was increased from 30% to 50% of adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” . In recent years, few changes have been made. However, as of 2006, all 501(c) (3) organizations must make their T-990 forms publically available, and as part of the fiscal-cliff bill, limits on deductions and exemptions were reinstated under Pease and the Personal Exemption Phaseout.
These limitations on deductions already have many non-profit groups, like the Alliance for Charitable Reform, concerned that they may adversely affect donations from taxpayers, especially among taxpayers in the highest marginal tax bracket. Meanwhile, lawmakers are beginning to consider ways to address the federal deficit through tax reform. Hence, lawmakers must determine whether the marginal impact of the income tax deduction for charitable donations is greater than the infra-marginal impact. In other words, does the charitable contribution deduction incentivize taxpayers to increase their donations enough to outweigh the cost of lost government revenue, and does the increase in charitable contributions contribute to society by providing a “public good”?
This hearing will hopefully contribute to the dialogue surrounding the fate of the charitable contribution deduction as lawmakers listen to the testimonies from non-profit groups and from experts on previous proposals for modifying the deduction.
See also: Tax Foundation: Time to Reform the Charitable Contribution Deduction?
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