Thursday, February 26, 2009

Taking Aim at the Independent Sector?

If a government increases the marginal tax rates on its citizens, will that lead to more or less money being donated to non-profit organizations (churches, charities, and so forth)? In the United States, that has been an interesting economic question because, for people who itemize deductions (mostly higher income individuals), such donations are tax deductible. Therefore, a change in marginal tax rates has offsetting effects. For example, when marginal tax rates decline, individuals have more money to contribute to charity, but the value of the tax deduction goes down (effectively increasing the “price” of the deduction). Empirical evidence has been ambiguous as to whether one of the effects dominates the other.

If the reports in today’s newspapers are correct, we may have the opportunity to have a “natural experiment” in this regard. Apparently, the Obama administration is proposing to increase our top marginal tax rates but to “cap” the corresponding deductions for charitable contributions as if the marginal tax rate had not changed. If this happens, Americans would have less money to contribute to non-profit organizations, but without the favorable “price” effect.

If I were involved in a non-profit organization that relied on donations, this proposal would make me feel like the deer in the classic Far Side cartoon who was born with a bull’s eye on his chest. “Heck of a Birthmark, Hal”, another deer comments to him. If the Obama administration has a deliberate goal to reduce Americans’ contributions to churches, charities and other non-profit organizations, this proposal would seem to fit the bill. But, that’s a testable proposition; perhaps there are general equilibrium effects to the overall economy that will countervail. I’m always ready to look at the data.

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