It’s unlikely you are feeling charitable today, especially since taxes are due soon. 2013 marks the 100th anniversary of the federal income tax—and with it, the complex and contentious relationship between taxation and philanthropy.

The U.S. has a strong, long-standing tradition of philanthropy, consistently ranking first worldwide in terms of dollars given. If giving patterns hold, Americans will have collectively contributed approximately $300B to charity in 2012, roughly 2% of GDP, about three quarters of which comes from individual contributions.

The section governing charitable contributions deduction is one of the oldest in the tax code, passed in 1917. The tax benefits for philanthropy have survived this long because of the perception that subsidizing giving incentivizes more giving than the amount spent to achieve it. However, at a time when government budget cuts, fiscal cliffs, sequesters, furloughs, and general austerity have made the need for charitable social services even more dire, the charitable contributions deduction has come under increasing pressure. The sheer size of the charitable tax deduction, which costs the federal government over $40 billion a year makes it a tempting target.

But according to Rethinking the Deduction for Charitable Contributions, evidence that the tax deduction encourages people to be more charitable is inconclusive:

A number of more recent studies, however, that use arguably better data than earlier research have resulted in estimates of the charitable contributions price elasticity that are both statistically and quantitatively less than unity…These lower estimates of the price sensitivity of giving have caused some to question the efficiency of the charitable deduction, [since new numbers imply] that a portion of the revenue foregone as a result of the deduction does not stimulate more charitable giving.

There is another element of the charitable deduction many find problematic: it consistently favors the wealthy, making it “cheaper” to give if you have more money than less. For example, if your marginal tax rate is 25%, then every dollar you donate to charity only costs you 75 cents thanks to the tax break the IRS offers. However, if your marginal tax rate is 39.6%, then each dollar you donate now costs only 60.4 cents. As Joseph J. Cordes notes in “It’s Time to Rethink the Charity Deduction,” if we want to “reward” individuals who give to charity, why should such rewards “be distributed disproportionately with respect to the income of the giver?”

Interestingly, The Chronicle of Philanthropy found that the wealthy were actually significantly less generous than those less fortunate even though they benefit the most from the deduction.

According to a study by the Chronicle of Philanthropy, the median household gives approximately 4.7% of their discretionary income to charity. This ranges quite significantly by state (as high as 10.6% in Utah to a low of 2.5% in New Hampshire), metropolitan area, and income level. You can view their interactive tool, How America Gives, to explore charitable giving patterns by state, city, and neighborhood.

The non-profit community has been up in arms fearing a decline in giving if this deduction is reduced or abolished. We may think giving to charity is driven by altruism, but much charitable giving may be compelled instead by generous tax incentives. United Way Worldwide reported that 62% of respondents from their Charitable Tax Deduction Poll would reduce their giving by a significant amount (25% or more) if the deduction was scaled back or eliminated.

At the heart of the issue is also a debate about the role of government versus philanthropy—which is better at delivering critical social services? In the Chronicle of Philanthropy’s analysis, “blue” states generally contribute more taxes to fund generous government social programs and tend to give less to charity. But blue states have better health and social outcomes than red states, which must rely more on private donations to fund social programs.

The categorization of what constitutes a “non profit” is another critical component of the debate. Private philanthropy is not always well coordinated or based on meeting the greatest need. Over a third of charitable giving in the U.S. goes to religious institutions, and groups such as the National Rifle Association receive the same tax treatment as donations to feed the poor.

Finally, no curation around taxation and philanthropy would be complete without an excerpt from Ayn Rand. A controversial writer and philosopher who pioneered Objectivism, she considered charity to be harmful to human relationships when institutionalized and held as a moral duty.

Additional Readings:

Image credit: Kris Litman via flickr

About The Author

Hui Wen Chan

Hui Wen Chan has worked in both the private and nonprofit sectors. She has advised clients across a variety of industries at Sagent Advisors, Inc. and Mercer Management Consulting (now Oliver Wyman Group). She also served as a Program Officer for the William J. Clinton Foundation’s pediatric HIV/AIDS program in Beijing, China. Most recently, she was a Harvard Business School Leadership Fellow and Associate Director at the International AIDS Vaccine Initiative, focused on strategic planning and business development. Hui graduated with Honors from Harvard College with a Bachelor’s Degree in Economics. She also holds an MBA from Harvard Business School, where she focused her studies on social enterprise and impact investing.