Tax Reform Must Include Charity Reform

Jeffrey H. Joseph Professor, George Washington University School of Business
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Major tax reform is on the table. Most liberal and conservative politicians agree it needs doing. As various lobbying groups call for cutting this or saving that, we can expect constant calls by others for offsets. To many politicians, this becomes an automatic call to raise taxes on the wealthy in order to offset tax cuts elsewhere.

Given the size of the deficit and the new administration’s determination to increase spending on national defense and infrastructure, tax reform will inevitably evoke creative schemes for increasing revenues one way or the other.

Here’s an idea you have likely never heard before: Eliminate or scale back the tax break for donating to lousy charities. New revenues raised by that option will also serve the public by forcing improvements to the charity sector’s fundraising and spending practices.

Americans give an estimated $373 billion annually to charity, with $264 billion coming from individuals. Yet the news has seen no shortage of reports on disappointing charities over the past few years. Consider the New York Times report last year that Wounded Warrior Project was wasting donor money on five-star resorts.

Or consider the Disabled Veterans National Foundation (DVNF). CNN reported in 2012 that DVNF had raised $55 million since its inception five years earlier, and yet most of the money had wound up in the pockets of solicitors working for the charity. While the foundation claimed that it had sent care packages by the truckload to needy vets, those goods included 2,600 bags of cough drops and 11,500 bags of coconut M&Ms.

In another case, investigators with the network found another veterans charity that raised $29 million over a four-year period and yet gave only 2 percent to vets. When they tried to ask the charity’s president about it, he sped away—in a vintage Rolls Royce.

This is sadly more common than people want to admit. The Tampa Bay Times named its 100 worst charities in 2013, calculating that these charities spent close to $1 billion on outside solicitors while spending only $44 million on direct cash aid. Keep in mind this is just based on 100 groups out of 1.5 million nonprofit organizations.

Efforts to curb charity abuses have thus far been underwhelming. While the mainstream media can occasionally call out a big fish, such as Wounded Warrior Project, lots of little fish fly under the radar.

And regulatory agencies aren’t much better. States would run into legal barriers trying to tell a charity how to spend its money. A 1988 Supreme Court ruling in Riley v. National Federation of the Blind of North Carolina struck down a Connecticut law prohibiting charities from spending an “unreasonable” amount of money on solicitations. That’s why a “disabled veterans” charity can—legally—create a contract whereby 99 percent of the proceeds from a fundraising campaign go into the solicitor’s pocket.

But the government doesn’t have to give a tax break to a citizen or corporation for making a charitable donation. The tax deduction is old, but was not part of the original 1913 tax law, so the parameters of the deduction are malleable.

With that in mind, Congress should change the law so that only donations to efficient charities are tax-deductible.

How would we define efficient? As Shakespeare wrote, “Ay, there’s the rub.” The missions of charities are extremely broad, spanning international aid to medical research to animal welfare to education, and efficiency within any field is up for debate. But common across charities is the percentage of money they spend on programs versus overhead. What exactly the standard should be is debatable. One potential standard would be a charity spending at least 65% of its budget on its programs.

This is a standard shared by two charity watchdogs, the BBB Wise Giving Alliance and CharityWatch. The Wise Giving Alliance will only give its seal of approval to charities that spend at least 65% of their budget on programs. CharityWatch uses the 65% figure as a marker of what a C-graded charity is on its scale of A to F grades.

(One difference between the two is that the Alliance allows charities to count some fundraising costs as “educational” program spending, which for a large charity can add up to millions of dollars a year. CharityWatch doesn’t allow this gimmick.)

What of the objection that the 65 percent threshold is an arbitrary figure? It begs the question: How can the federal government justify arbitrary numbers to determine whether taxpayers get to claim charitable deductions?

Sorry, those lines in the sand were crossed years ago. At one point, taxpayers were able to deduct 100 percent of all contributions to any 501(c)(3) organization. No longer. Depending on adjusted gross income, charitable deductions can now be knocked down by as much as 50 percent. How can the government know which charities do a good job and are worthy of full deductibility? Again, the federal government has been leading the way—actually for decades—through the Combined Federal Campaign (CFC), which manages those charities the U.S. government supports with contributions from federal employees.

Plus, local United Way campaigns across America undergo a similar vetting process. Bottom line, as a starting point, the federal government and local communities have lots of experience evaluating worthy charities.

Back to tax reform: Eliminating a charitable deduction for inefficient charities would likely raise money for the government. According to the Congressional Budget Office, taxpayers claimed $211 billion in charitable contributions in 2014. The CBO recently calculated that trimming the charity tax deduction by eliminating deductions for small donors (those who itemize and give less than 2 percent of their adjusted gross income) would raise $229 billion over the next 10 years. The CBO notes that this would likely reduce overall giving to charity slightly, but large-dollar donors would still have a tax incentive to give to charity.

Other proposals being floated would reduce charitable giving, but would not have the benefit of incentivizing donors moving money to better charities. According to Forbes, President Trump has proposed a cap on itemized deductions, and has floated other ideas such as a capital gains tax on property donated to a foundation. Meanwhile, the House Blueprint for tax reform would reduce the percentage of Americans claiming a charitable deduction from 25 percent to 20 percent. An estate tax repeal would also reduce charitable giving, as inheritors no longer need the deduction.

These reforms individually could reduce overall charitable giving between 4.5 percent and 12 percent. But this would not result in any incentives for reform of charity efficiency.

This is not about generating long-term revenues to the Treasury. Donors will quickly begin learning which charities they’ve given to that aren’t worthy enough to qualify for tax deduction. Ultimately, as money shifts from bad to good charities (and bad charities reform their practices), government revenue from the deduction reform will fall.

That would be a net gain for all. It would shift funding to efficient private charities working towards alleviating some of society’s problems, thus reducing demands on the limited resources of government agencies.

The political Left has often tried to use the tax code as a weapon: To punish success or to socially engineer behavior such as “sin taxes” on junk food. However, a deduction for giving to charity is different. Reforming the charitable deduction is a tool that will encourage better behavior in the private nonprofit sector. That’s an outcome we should all be able to get behind.

Jeffrey H. Joseph is a business professor at the George Washington University School of Business in Washington, D.C.