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November 29, 2012

Why vague plans to limit tax breaks may soon die

(Continued)

Of the big three, charitable giving is the most discretionary (unless a family moves to a smaller house with a smaller mortgage, or a city or state with lower taxes). The charitable sector thus has the most to lose from a limitation on itemized deductions.

How much money is involved? In 2009, households with incomes of more than $200,000 claimed almost $60 billion in charitable deductions — or about 20 percent of total charitable giving in the United States that year. Households with incomes of more than $10 million claimed an average of $1.75 million each in charitable donations in 2009, and they accounted for roughly 5 percent of all giving.

Charitable giving reacts to tax incentives, and in response to any limits on deductions it could even fall by about the same amount as the increase in the tax bill, according to John List of the University of Chicago, who recently reviewed the literature on this subject. Other studies have suggested an effect about half as large. Even that smaller estimate, though, suggests that limiting deductions to $50,000 a year could easily reduce giving by tens of billions of dollars.

How long do you think it will take the charitable sector to figure this out?

This is just one way in which the $50,000-limit idea is likely to become less politically attractive. In addition, there are important questions about the proposal's design. For example, above the $50,000 limit on deductions, the tax incentive disappears. Below that threshold, though, the per- dollar tax break would still be tied to the individual's marginal-tax rate. As I have written before, it would be fairer and more efficient to replace a wide variety of deductions with flat-rate credits.

What's more, evidence suggests that charitable giving would be higher if the tax incentive took the form of a matching credit (which goes to the charity) rather than a rebate (which goes back to the individual). So rather than curtail the tax deduction for charitable giving indirectly, through a $50,000 limit on all itemized deductions, it would be far better to replace the existing deduction with a flat credit that would go to the charity.

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