Compromising the Safety Net: How Limiting Tax Deductions for High-Income Donors Could Undermine Charitable Organizations Patrick E. Tolan, Jr.* ABSTRACT With the election behind us, tax reform looms as the hot-button topic of the day. Based on election results, it is likely that the Obama administration will continue to push for the same types of reforms proposed in the 2013 budget. However, inadvertent consequences of the administration’s proposals, specifically those impacting charitable donations, may lead to unfortunate results in the rush to do something to break the gridlock on tax reform, especially while federal spending remains reduced or “sequestered” until the budget can be balanced. President Obama’s budget proposals have contemplated reducing the top rate for charitable deductions (and all itemized deductions) to 28%. Because America’s largest donors are those in the highest marginal tax brackets, efforts to limit deductibility of charitable donations could have a chilling effect on charitable giving. In this Article, the author looks at motivations for charitable donations and specifically at the impact of tax deductibility as a motivating factor. He takes a historical look at philanthropic surveys and econometric models and examines empirical data concerning impacts of significant changes to the tax code in the 1980s that could be used as indicators of what effect the proposed limitations on deductibility could have on donations. The author also considers impacts of the recent recession on the nonprofit sector, which has already been burdened by historically high numbers of unemployed individuals and children in poverty. Because the economic downturn has already stifled charitable giving at a time when the nonprofit sector faces high demands, any further erosion may be the straw that breaks the camel’s back. If tax changes dampen enthusiasm for * Associate Professor, Barry University School of Law. An earlier version of this Article was presented at the 2012 Southeastern Association of Law Schools’ Economic Challenges and Charitable Organizations Panel. I appreciate the many thoughtful suggestions provided during and after that presentation. In addition, I wish to thank Alyssa DiRusso, Marc Edelman, Miranda Perry Fleischer, Heather Kolinsky, and Grace Lee for their comments and suggestions regarding the ideas and arguments presented here and in earlier drafts. I also thank Mallory Pearce and Tiffany Walters for their outstanding research support. Any errors are, of course, my own. 330 SUFFOLK UNIVERSITY LAW REVIEW [Vol. XLVI:329 charitable giving even further, struggling charities may go under, and prospective new charities may not be able to get off the ground to pick up the slack. At the end of the day, government welfare programs, which are more costly than a tax subsidy for charitable donations, would be needed to meet the needs of citizens slipping through a crumbling safety net. TABLE OF CONTENTS I. INTRODUCTION ............................................................................................ 331 II. BACKGROUND ............................................................................................ 333 A. The Charitable Donation Deduction: Then and Now ................... 333 1. Inception of the Charitable Donation Deduction .................... 333 2. Present Deductibility ............................................................... 335 3. 2013 Budget Proposal and Expiring Tax Cuts ........................ 338 B. Justifications for the Deduction ..................................................... 340 1. Ideal Income Tax Excludes Charitable Donations from Income ................................................................................... 342 2. Efficient Subsidy Theory ........................................................ 345 3. Equity Theory ......................................................................... 350 4. Distributive Justice: Rawls Revisited .................................... 352 5. The Need for Salience ............................................................. 354 C. Charitable Deduction Evolution Throughout the Years ................. 356 1. Changes to Limit Deductions as a Percentage of Income ...... 357 2. Changes to the Pool of Tax-Advantaged Donors .................... 357 3. Rate Changes Throughout the Years ...................................... 358 a. Early Tax Rates: Wartime Spikes and Progressivity ........ 359 b. Major Rate-Change Reforms of the 1980s ....................... 360 c. Post-1980s Rate Changes: Increases, Relief, and Sunsets ............................................................................ 363 D. How Giving Has Changed in Response to Tax Changes ............... 363 1. The Early Years: 1913-1940 .................................................. 364 2. The 1940s and the Standard Deduction .................................. 365 3. Changes in the 1950s-1960s ................................................... 366 4. Changes in the 1970s ............................................................. 368 5. Tax Reform in the 1980s ........................................................ 372 6. The 1990s to the Present ......................................................... 375 III. DONATIONS DROP IN TIME OF SERIOUS RECESSION ................................. 376 IV. ANALYSIS AND RECOMMENDATIONS ....................................................... 379 A. The Charitable Deduction Should Not Be Reduced Now ............. 380 B. Severity of Proposed Tax Reform .................................................. 382 C. The Need for Continued Study ...................................................... 385 V. CONCLUSION ............................................................................................. 387 APPENDIX 1 ..................................................................................................... 388 2013] COMPROMISING THE SAFETY NET 331 “Charity is thus a blessed act that should suffer no discouragement from something so mean as the tax code.”1 I. INTRODUCTION More Americans⎯46 million⎯are presently living in poverty than at any time in the past fifty years.2 Even more disturbing, child-poverty rates have climbed to 22%, up from 16% just ten years ago.3 As demand for social services peaks, many newly unemployed or others who have never before needed social services will turn to charities, specifically their churches, for services because they do not know about public assistance or how to obtain it.4 “Superstorm Sandy” reminds us of how vulnerable people are to natural disasters as well as the critical role of nonprofit organizations in providing relief to disaster victims.5 Nevertheless, whether our hardships are from natural or economic disasters, what is most evident is the crucial need for the services of the charitable sector to help those who are suffering. Despite America’s unparalleled modern economic hardship, President Obama has proposed reducing tax relief for wealthy taxpayers who donate to charity.6 To the extent these changes could deter charitable giving, the 1. 147 CONG. REC. 2525 (2001) (statement of Rep. Philip M. Crane in support of the Charitable Giving Tax Relief Act). Congressman Crane had the support of 149 members of Congress in an earlier version of the charitable deduction reform bill he was proposing (calling for those taking standard deduction to also receive charitable donation deduction). See id. Crane’s remarks explain why many believe that charitable donations are fundamentally different than other personal donations. “Charity benefits both the giver and the receiver in like proportions. The act of giving elevates the heart of the giver. The act of receiving elevates the condition of the recipient.” Id. 2. See Marisol Bello, Poverty Affects 46 Million Americans, USA TODAY, Sept. 28, 2011, http://www.usatoday.com/news/nation/story/2011-09-28/millions-of-Americans-are-suddenly-poor/50593610/1 (since Census Bureau began tracking poverty data in 1959). “Hispanics and blacks living in poverty remain disproportionate to their population. So do people in families headed by single women, where more than one- third live below the poverty line.” Id.; see also How America’s Losing the War on Poverty, NPR, Aug. 4, 2012, http://www.npr.org/2012/08/04/158141728/how-americas-losing-the-war-on-poverty [hereinafter War on Poverty] (noting more poverty than at any time since war on poverty in 1960s). 3. See G. Jeffrey MacDonald, The New Face of American Poverty Is Often a Child’s, USA TODAY, Oct. 13, 2011, http://www.usatoday.com/news/religion/story/2011-10-13/poverty-children-church/50761118/1 (detailing child-poverty statistics). “[C]hildren are the poorest age group in our country because their families⎯typically single moms trying to make it⎯can’t do so because of this flood of low-wage work that we have.” War on Poverty, supra note 2. 4. See MacDonald, supra note 3. Robert L. Fischer, Case Western Reserve University’s codirector of the Center on Urban Poverty & Community Development, noted that “faith-based service programs tend to catch people who fall through the cracks of other safety nets.” Id. 5. See Superstorm Sandy Sparks Huge Need for Relief, HERALDNET, Nov. 10, 2012, http://www.heraldnet.com/article/20121110/NEWS02/711109956. “[T]he population density of the Northeast may require a response that surpasses Katrina in the number of people served and resources required.” Id. (citing Salvation Army Major Darryl Leedom). 6. DEP’T OF TREASURY, GENERAL EXPLANATIONS OF