Charitable Giving: Current Vs. Flat Taxation Systems

The amount people give to charity is impacted by several factors.  The current progressive with deductions taxation system promotes charitable giving in many ways.  Prime among these is the fact that charitable contributions are tax-deductible, causing them to be less expensive to the giver.  For example, let us examine someone in a 30% tax bracket; for simplicity we will assume that all of their income is taxed at a 30% rate.  Thus for every $100,000 they make, $30,000 will become tax losses, with a net personal income of $70,000.  However, as charitable contributions are a legitimate deduction, for every dollar they contribute, their taxable income is reduced by a dollar.  Thus, a $10,000 donation reduces their taxable income to $90,000, so they pay only $27,000 in taxes, with a net personal income of $63,000.  The actual cost of donation to the person is amount times (1-tax rate).  This means that the cost of giving was reduced by the rate of taxation, effectively making it cheaper for people to give money (so long as the amount of deductions is sufficient so that they itemize).  From an economic standpoint, this provides a significant incentive to people to donate, as it is well known and established that people often prefer to choose where their dollars go, be it to a church, society, or other non-profit organization, rather than have the government distribute them.

In recent years, there has been a significant push to move to a so-called “flat” tax rate.  Flat taxation involves income, generally above an amount determined by the size and makeup of the household, being taxed at a constant marginal rate.  There are already five US states which have flat taxation on personal income tax: Illinois, Indiana, Massachusetts, Michigan, and Pennsylvania, at a rate ranging from 3-5.3%.  The Federal income tax, however, remains progressive. 

There are many different varieties of flat taxation proposed.  The most common seems to be flat wage taxation with deductions, wherein income is redefined purely as wages and deductions can be applied much like the current system, with the remaining amount above a certain threshold being taxed at a constant rate; this has been generally proposed to be at or around 17%. 

However, major opposition to this plan has been voiced.  Taxation at the margin is currently designed to help reduce the burden on the poor; taxing each extra dollar of income of someone making $30,000 is going to have far more impact on them than someone making $250,000.  The marginal difference of that dollar is huge; without sizable exemptions, the fairness of the system comes into questions.  Another argument is the affect that this system would have on charitable contributions. 

From a purely economic standpoint, the flat tax would likely reduce contributions.  The majority of charitable donations are made by persons who have excess income; someone making $200,000 per year will have more spare money which can be donated than someone making $20,000.  A flat taxation system will actually lower the taxation percentage on the wealthy and those with higher incomes (anyone who would originally have been paying more than the proposed rate), making the cost of donations relatively higher.  This increase in cost will cause, from a pure economic standpoint, a reduction in the amount of charitable giving.

However, cost is not the only criteria people use when determining how much to give.  It has been shown that charity is fairly inelastic; that is, people will give approximately the same amount regardless of expense to them.  Historical data seems to demonstrate that contributions to charity are more correlated with income growth than taxation rates.  This means that the increased cost brought on by the flat tax should have little effect on the amount given to charity.  Elaine Chao, former president of the United Way believes that the flat tax will actually increase the amount given to charity “because it will eliminate the features of the tax code that hinder economic expansion, wealth creation, and income growth.” In fact, she even goes so far as to recommend eliminating the deduction credit for contributions, as keeping it would require a higher overall tax rate to keep the governmental inflow from income tax revenue-neutral.