The Fiscal Cliff – Dumb and Dumber?

The Wall Street Journal on Friday morning carried a front page story that said people are making charitable contributions before year-end because they think that the U.S.Congress might end the ability to take tax deductions for charitable contributions.  Those of you who have read some of my previous posts are no doubt aware that I believe that actions that may be politically “smart” or expedient may not be in the best interest of the country.  You are probably also aware that I have a high regard for the work of the private non-profit community in helping and giving hope to those in need.  So you would probably not be surprised that although I expect the congress to do “dumb things” at times, that this would be a move from dumb to dumber.

Until today, I thought that the dumbest thing they might do in avoiding the “fiscal cliff” would be to not keep the tax on dividends equal to the tax on capital gains.  I wouldn’t have much concern with raising the rate back to 20% – I wasn’t sure that reducing it from 20 to 15% was a particularly productive move to begin with.   But making the tax rate the same on those two types to revenue was one of the smarter things that the congress has done in a long time.  If my reasons for saying this are not obvious, we’ll try to address that in another post because while that would be dumb, the contribution elimination would be dumber.  And so we’ll start with the worst possibility first.

In recent elections the news media has begun calling taxes paid by politicians a measure of their willingness to “give back”.  While they don’t say what they are giving back to, I presume they mean giving back to our society in general. Since much of government tax money now goes for welfare, I would not argue with that characterization a lot.  However, to be fair they should add to the taxes paid number, the amount given to charitable organizations. Some that pay more taxes apparently give away little or nothing, while others who may pay less in taxes, give away a great deal.  Money taken as an allowable tax deduction must be given to a non-profit organization that is certified by the IRS as doing things that are for the “public good”.  These contributions, given voluntarily,  would clearly seem to be a measure of “give back”.  So if one assumes that our taxes are going for more than politician’s salaries and to pay bureaucrats, then the sum of  both taxes and contributions should count.  And the allowance as tax deductions for charitable contributions is certainly “fair”.  In fact, one might argue that they should be tax credits rather than simply deductions.

It must be said, however that people’s willingness to give money away is certainly encouraged by the fact that they are tax-deductible.  So taking away the deduction would likely reduce the amount given.  What might be the effects of eliminating the deduction?  Let’s look at a hypothetical example:

Assume a couple makes charitable contributions of $10,000 and is in a 30% tax bracket.  (The rule of arithmetic examples is; if one is going to assume something, make it something easy to work with.)   If that deduction is eliminated, what is the increases in taxes paid?  The answer is that their taxes will go up by $3,000.  What is their likely reaction?  Well, it depends on their values, motivations and other commitments.  But if they want to maintain their disposable income and take a rational approach, they would reduce their contributions by $3,000.  So if the government spends that $3,000 for welfare and spends it as efficiently and effectively as the non-profit did, it’s a wash.  Neither society nor our couple are any better or worse off.  If private non-profits are more effective and efficient than government, then our couple is OK, but society is worse off.

But, of course, most of us are not going to react in this coolly rational fashion.  Some folks may be primarily motivated by the tax deductibility – those that think the deduction should be eliminated seem to feel this way.  If this is the case, then they would eliminate the total $10,000 contribution and so government spending would have to increase by $7,000 more than the tax increase to keep society from not being worse off.  Others may feel that what they are giving to is something they feel strongly enough about to continue giving the full $10,000 whether it’s tax-deductible or not.  If they continued to give the $10,000 and reduce expenditures on something else, the “give back” amount increases by $3,000 and society is better off.   In reality, the reactions in total would probably  be across the board between these extremes.  A reasonable assumption might be that the precise rational calculation would not be done by many, but there would be on average a decrease in charitable contributions, maybe 50%, in which case society would only be $2,000 worse off.

Except it could be much worse  than losing the whole $10,000 of public good.  I have worked with many non-profit organizations that I have worked with – like the food bank and the homeless shelter, etc.  Most depend on private contributions for operating revenue.  How many organizations can take even a 20-30% sudden reduction in revenue and survive?  Not many.  And if we start losing entire organizations we are losing much more than the mere obvious dollar value calculated above.  In addition to the paid staff, whose salaries are generally less than government employees, we are losing the value of volunteer time.  Most of these organizations depend on unpaid volunteers to do much of what they do.  Last year in Tulsa the estimate of the dollar value of the volunteer time was several times higher than the total money contributed to the United Way.  If the organizations go away, that volunteer time will too.

We need to balance the Federal Budget, and the longer we wait, the worse it gets.  Taxes probably need to go up, but that money needs to go for debt reduction, not for new expenditures.  In fact, government expenditures need to be reduced along with some tax increases.  There will be pain involved.  We will need the private non-profit sector to do more, not less.  In this environment doing nothing would be dumb, but doing some things would be dumber.

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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