18 December 2012

Don’t Mess with the Charitable Deduction!

As Wall Street waits with bated breath to learn the details of the fiscal cliff negotiations happening right now in Washington, the fate of American civil society hangs in the balance. Will Speaker Boehner and President Obama spare the charitable deduction? Or will they sacrifice it to pay for tax cuts and government spending?

Yale economics professor Robert Shiller put it politely when he wrote “Please Don’t Mess With the Charitable Deduction” in last Sunday’s New York Times. Professor Shiller said “[w]e have to clear our minds of the idea that the charitable deduction is a ‘loophole’ that benefits the rich at society’s expense. Income that is freely given away should not even be considered as taxable income.”

Professor Shiller discusses all the good things that charity has done for the country and how the impulse to philanthropy springs from our deepest values of self reliance and altruistic regard for others. And even if charity is sometimes motivated by vanity, Shiller observes, the overall effect on society is salutary.

As I argue in my forthcoming article “Renegotiating the Charitable Deduction” to be published in the January edition of the Exempt Organizations Tax Review, proposals to reform the charitable contribution deduction tend to confuse the purpose of the charitable deduction with its economic effects. The purpose of the deduction is to ensure government neutrality toward American civil society by exempting charities and the gifts that sustain them from taxation. The effect of this neutrality is to reduce the cost of giving. That economic effect, however, has been misconstrued by some who believe that the purpose of the charitable deduction is to provide a subsidy to philanthropists, many of whom are wealthy.

Subsidy is the wrong way to think of the charitable deduction because it leads to troubling constitutional problems such as the separation of church and state. Worse, subsidy theory puts civil society under government control, for, as Alexander Hamilton wrote, “[t]hat power which holds the purse strings absolutely, must rule.”(Letter from Alexander Hamilton to James Duane, (Sept. 3, 1780).)

Democrats and Republicans have different ideas about how much the government should take from the nonprofit sector to fix this mess that we’re in, but we would be wise to consider the possibility of leaving well enough alone. Professor Shiller should have been less polite: Don’t mess with the charitable deduction!

Alexander Reid is of counsel in Morgan Lewis’s Tax Practice. Prior to joining Morgan Lewis, he served as legislation counsel for the Joint Committee on Taxation, where he advised members of Congress and staff regarding tax policy and drafted legislation, hearing publications, and technical explanations of tax legislation. He has also served at the U.S. Department of the Treasury, Office of Tax Policy, as a tax policy fellow. Reid is chair of the Tax-Exempt Organizations Committee of the District of Columbia Bar and is vice chair of the D.C. Bar Tax Section Steering Committee.