Making the Charitable Sector More Charitable

Authored By 
Jennifer McTiernan
Blog contributor 
Policy Fellow
Publication date 
September 30, 2015

It might come as a surprise to learn that the government is subsidizing what Robert Reich has called a “plutocratic bias”  in the charitable sector at a steep cost to the national treasury. This is in large part because the charitable tax deduction, which serves as the charitable sector’s primary financing mechanism, creates tax incentive structures for donors that are steeply regressive. In 2012, tax subsidies to the charitable sector cost the government more than $50 billion in lost tax revenue. Given the billions of dollars in government subsidies and donations, it seems only reasonable to ask if this sector actually supports “charity” by meeting the needs of the most disadvantaged in our society, which is what we have historically understood the work of the charitable sector to be.

The answer: it does not. The best estimates suggest that only 33% of total giving is directed towards meeting the poor’s basic needs.  Donations to religious organizations (which capture the majority of donor dollars) aside, empirical data shows the charitable sector largely subsidizes donations by the rich to organizations benefitting the rich, such as educational institutions and hospitals. Moreover, the tax advantage of the charitable tax deduction increases as one’s income increases. For this reason, “the opportunity cost of virtue decreases as one moves up the income scale.” This upside-down subsidy distorts the charitable tax deduction from a powerful tool to aid the needy into one that leads to the production of mega-donors who give to elite institutions that largely benefit the elite.

Consider these high-profile examples of the mega-donor phenomenon: billionaire donor financier Stephen Schwartzman just gave Yale University $150 million in May 2015 for a cultural center, while hedge fund manager John Paulson gave Harvard $400 million weeks later for its engineering school. As part of the deal, Yale’s new cultural center will bear Schwartzman’s name, and Harvard’s engineering school will be rechristened in Paulson’s honor.  Both will receive handsome tax deductions as a result of their self-aggrandizing gifts (with no decrease in that deduction to account for the ostensible value in having buildings with their names on them). Mind you, Harvard and Yale are the two wealthiest universities in the world, each with endowments over $20 billion.  This raises the question: should the government be subsidizing hundred million dollar donations from the wealthy to such well-endowed institutions? Is this use of the charitable tax deduction defensible?

The tax code is directly implicated in this: there is no economic incentive for low-income people to donate to charity since the only way to claim a charitable tax deduction is if you itemize, and most low-income people do not itemize their tax returns. That fact alone prevents millions of taxpayers from helping to set the agenda of the charitable sector in the way that the wealthier are incentivized to do through the tax benefit they receive from the charitable tax deduction.  To make matters worse, studies show that people are more likely to give to causes that they themselves can relate to, making it even less likely for the biggest givers to provide for the needs of strangers. Indeed, as income rises, the tendency to give to meet the basic needs of the poor decreases, from 10% of total giving if one’s income is under $100,000, to only 4% of total giving if one is a millionaire. This problem is exacerbated as a result of the growing inequalities in our society, and the widening gap between the rich and the poor, with a shrinking middle class.

Hitting closer to home, many charitable organizations in striving cities like New Haven provide a lion’s share of basic services to the needy in the region, while suffering from a shrinking corporate donor base and competing with national or international non-profits for limited dollars and attention (the ALS Bucket Challenge comes to mind,  which became a media sensation, and directed donor dollars to a very specific national cause).  One researcher found that only 5% of giving is directed towards local service activities  – a paltry proportion. Whether a donor gives $100 to a homeless shelter in New Haven or to Yale University, the tax benefit to the donor is essentially the same, even though this cuts against our historical and cultural understanding of the word “charity.” It is difficult to see how this reality is defensible.

What to do? The tax code must change. I call for a reform to the tax code that rewards donors who give to organizations certified by “Social Enterprise Zones,” serving communities that are poor in resources but high in social need.  These Zones would most likely be concentrated in urban centers such as New Haven, Connecticut and Detroit, Michigan, as well as in rural areas, where the corporate and private donor base has dried up or never existed.  These Zones would certify organizations serving the needs of that community. Once certified, an organization could double the tax benefit for donors. So, one dollar given to an organization certified by a “Social Enterprise Zone” would count as two dollars for the purposes of the charitable tax deduction, thereby incentivizing the flow of donations to organizations that serve communities with the highest need. In this way, donors would be rewarded for meeting the needs of the underprivileged in resource-poor communities, where a $100 donation will deliver more value to society than it would if donated elsewhere. And by doubling the amount the donor can deduct from her taxes, the tax code could reshape a charitable sector that corresponds with our shared notion of charity and the importance of meeting the basic needs of the poor.

Jennifer McTiernans’s research focuses on the law and policy of social enterprise, with a specific interest in alternate corporate structures designed to deliver social value as well as profit. She was an ISPS Graduate Policy Fellow (2014-2015) and graduated Yale Law School (2015) .

Area of study 
Taxation