Legislators in the 40 states now facing budget shortfalls would be ill advised to follow the recent Massachusetts House of Representatives example of trying to raise revenues by repealing the state’s new tax incentive for charitable giving. The sluggish economy has not only lowered state revenues, it has also increased the need for philanthropy. A better course nationwide would be for the seven states that now lack these incentives to do the opposite and enact charitable deductions as soon as possible.
Charitable Deductions Work
There is no doubt that these incentives work. The federal government introduced tax incentives for charitable giving in 1917, when the national income tax itself was just 4 years old. Since then, 34 of the 41 states that have an income tax have followed the federal example and created incentives for charitable donations. States lacking such incentives in their income tax codes have consistently scored poorly on the national Generosity Index, because they have relatively high ranks in income and relatively low ranks in giving.* In the 1999 tax year, the latest for which figures are available, all but one of the eight states (including Massachusetts) that had income taxes but had not enacted incentives scored at or near the bottom of the Generosity Index.
The incentives work not by influencing whether donors give, but how much they give. Economists call this the “price-elasticity” of charitable contributions, meaning that giving increases as its cost declines, and vice versa. Federal and state tax incentives combine to reduce the costs of giving by the amounts saved in taxes. Though all gifts can benefit, the effects are greatest on major gifts, and especially on gifts of stocks and bonds that have risen in value over time, where two tax incentives are at work: Donors deduct the appreciated value of the securities given, and also avoid the capital gains taxes they would have paid if they had profited from the sale of the securities.
Of course, as more taxpayers in a state learn about these benefits, the number of donors who take advantage of them grows. Since by far most of the dollars donated to charities each year come from individuals (85 percent, compared to 10 percent from foundations and 5 percent from corporations), and since more than half of individuals’ donations come from taxpayers earning over $100,000, the effects of these incentives on charitable giving are huge, and the beneficiaries include every citizen.
Because philanthropic tax incentives are beneficial and all voters are their beneficiaries, they are politically potent. Massachusetts’ giving incentive was enacted in 2000 after a ballot initiative won handily with 72 percent of the vote— even larger than the 59 percent support received by a significant tax cut on the same ballot. In earlier years, the legislature had failed six times to pass an incentive for charitable giving; it was routinely buried in committees and never reached a vote. This was especially galling because for years the state had ranked dead last on the Generosity Index, thanks to our low rate of giving and our high income—a region-wide phenomenon in New England, with Rhode Island, New Hampshire, and Connecticut ranking just above us in the cellar. New England’s number-one strategic problem in philanthropy has been that we are the wealthiest region in the country, and we give the least to philanthropy. To address this issue, a group of us have mounted a series of initiatives to change our culture of philanthropy and raise charitable giving through donor education.
In 1997 we first published the Generosity Index, and then in Massachusetts we launched the Catalogue for Philanthropy, an annual publication that showcases the excellence and values of philanthropy and is mailed to over 100,000 affluent families statewide in the year-end holiday giving season. In 1998, we created “Giving New England,” a regional network of state-based task forces (including “Giving Massachusetts”) that brings together the various constituencies in philanthropy (grantmakers, fundraisers, charities, philanthropic and financial advisors, scholars, the media, etc.) to promote philanthropy. Giving New England mounted a highly informative website for donors. In 1999 we launched a public relations campaign based on the Generosity Index and worked to increase media coverage of philanthropy. In 2000 we campaigned statewide at the grassroots level to propose and pass the tax incentive, which became effective in the tax year 2001, when the Catalogue website also came online. Other infrastructural enhancements are in the works.
Tax incentives, in other words, have been part of a comprehensive strategy designed to transform our giving situation and, ultimately, our quality of life as a Commonwealth, in perpetuity. These efforts began almost immediately to show positive results—giving in Massachusetts and New England turned sharply upward starting in 1997. From 1997 to 1999, New England became the fastest-growing region in the country in charitable giving, led by Massachusetts, which was growing at the third-highest rate in the nation—our average itemized charitable deduction rose in those three years by 43 percent; our total giving rose by 57 percent; and we added over $1.1 billion to philanthropy, over and above what we would have added following our previous growth trajectory. Moreover, the rate at which we created new private foundations also showed a sharp increase, doubling in 1997 and nearly tripling in 2000, compared to our annual rate for the years 1991 to 1996.
Tax Incentives as Public Policy
Philanthropy and government both serve the “public good,” but they do so by different means. Philanthropy—giving time or money—is voluntary, with each donor deciding what to support. Paying taxes, as we are keenly aware, is required, and the government decides how to spend the money, with the effect that almost all tax dollars are spent on government itself and only a tiny fraction goes to charitable public services.
Charitable tax incentives are a good example of how philanthropy and government can complement each other: They use what is required (taxes) to leverage what is voluntary (charitable giving) at a highly efficient ratio. In Massachusetts the ratio is 17 to one; for every dollar deducted from personal income taxes, $17 are donated to good works.
Two studies—one by Harvard economist Martin Feldstein and one by economists at the Beacon Hill Institute of Suffolk University—predict that a tax incentive will produce more dollars for the public good of the Commonwealth than are “lost” in forgone tax revenue. No one has challenged either of the studies, which themselves disagree only on the size of the effect: A tax incentive will produce an additional $220 million of charitable giving according to Feldstein, $270 million according to the Beacon Hill Institute, whereas both put the lost tax revenue at under $200 million in 1999 and less than that today.
A tax incentive is not a proper instrument of fiscal repair; it is a strategic, long-term financial instrument guiding private dollars toward broadly defined public-interest ends. Tax incentives guarantee beneficial use of the dollars involved, because they are awarded only after and on account of a charitable donation. By contrast, legislators have no influence over how taxpayers use tax-cut dollars.
Massachusetts legislators have lately been fond of saying our budget crisis is so severe that “everything is on the table.” We in the philanthropic community have made two basic arguments as to why charitable tax incentives should not be on the table. First, strategic, long-term, financial instruments like tax incentives should not be used for tactical, short-term fiscal purposes. Second, philanthropy is not a special interest; it is an interest of the entire body politic. Every citizen of Massachusetts is a beneficiary of philanthropy in the enhanced quality of life it brings all of us.
The House of Representatives did not heed these arguments and in their latest fiscal package came up with a proposal that is disingenuous, unwise, and unworkable, furtively included in a comprehensive revenue bill so that no representative actually had to vote on the charitable tax deduction by itself, in full light of day. They claimed to “postpone” the tax incentive (which was, however, already in effect for the 2001 tax-filing year) and to attach a “trigger” mechanism that would determine when it could be reinstituted, based on when the performance of the Massachusetts economy improves to a certain point.
The House’s “postponement” was disingenuous and fooled no one, because when the trigger was analyzed it was discovered that the earliest the incentive could return would be somewhere between 2009 and 2014. The media unanimously and bluntly referred to the measure as a “repeal.”
It was unwise as public policy, because the needs of the unfortunate, and the need for incentives to increase giving, rise when the economy goes down and decline when the economy goes up. Therefore to yoke the giving incentive to economic prosperity is the opposite of sound public policy.
It is unworkable because incentives, to be effective, must be constant and reliable. How are fundraisers and donors to know when the incentive is operative and when it is not? Who is going to tell them? What are donors and fundraisers to do about multiyear pledges to capital campaigns? An on-again/off-again, unpredictable tax incentive is effectively no incentive at all to philanthropy as it actually works.
A New York Times article published as we go to press reviews fiscal repair measures now being considered by state legislatures nationwide, and thankfully no other state was mentioned as considering the repeal of charitable tax incentives. Philanthropists, however, must be vigilant if we are to protect the public interest from pernicious legislative politics.
We should also be alert to new opportunities for partnerships with government—a possible example at the national level might be the Charity Aid, Recovery, and Empowerment Act sponsored by Sens. Rick Santorum, R-Penn., and Joe Lieberman, D-Conn. Above all, we have a teaching job to do—to discourage the common misconceptions, among both public officials and private citizens, that government and philanthropy are somehow antagonists for a fixed amount of public-interest dollars. It is in everyone’s interest to increase charitable giving, especially in a difficult economy, and especially when government expenditures are declining. The future of charitable giving is bright; the future of public funding is not.
* The index’s calculations use IRS data to determine a state’s national rank in average adjusted gross income; then the state’s rank in average itemized charitable deductions is subtracted from the first ranking. The results are then ranked themselves to provide the Generosity Index rank. For example, in 1998, Massachusetts was ranked third nationally in income but placed forty-second in itemized giving. The difference, -39, was the largest of all the states, making the Bay State last on the Generosity Index.
George McCully is a trustee of the Ellis L. Phillips Foundation of Boston.