Curtail the Deduction for Charitable Giving

Background

Current law allows taxpayers who itemize to deduct the value of their contributions to qualifying charitable organizations. (Taxpayers whose deductible expenses are less than the standard deduction can minimize their tax liability by claiming the standard deduction instead.) By lowering the after-tax cost of donating to charities, the deduction provides an added incentive to donate.

Two restrictions apply to the deduction. First, deductible charitable contributions may not exceed a certain percentage of a taxpayer's adjusted gross income (AGI). (AGI includes income from all sources not specifically excluded by the tax code, minus certain deductions.) The 2017 tax act temporarily increased that percentage from 50 percent to 60 percent for cash contributions through the end of 2025 but retained the 50 percent limit for other types of contributions. In 2026, that temporary provision will expire, and subsequent deductions of both cash and noncash charitable contributions may not exceed 50 percent of a taxpayer's AGI. The second restriction, which was temporarily lifted by the 2017 tax act but will resume in 2026, reduces the total value of certain itemized deductions—including the deduction for charitable donations—if the taxpayer's AGI exceeds certain thresholds ($315,100 for taxpayers filing singly and $378,100 for taxpayers filing jointly in 2026). Those thresholds will be adjusted, or indexed, to include the effects of inflation.

Deductions for charitable contributions accounted for 3 percent of AGI among those who itemized on their 2016 tax returns. Taxpayers claimed $234 billion in charitable contributions, $169 billion of which was in the form of cash, on 37 million tax returns. Because of temporary changes enacted in the 2017 tax act, including an increase in the standard deduction, the Congressional Budget Office projects that the number of taxpayers who itemize will fall by more than 60 percent beginning in 2018 and the total value of itemized deductions will fall by about 35 percent. Absent those legislated changes, the amount of itemized deductions was projected to grow slightly faster than income.

Option

This option consists of two alternatives that would curtail the deduction for charitable donations. Under the first alternative, only the amount of a taxpayer's contributions that exceeded 2 percent of his or her AGI would be deductible. Under the second alternative, the deduction would be eliminated for noncash contributions. Both alternatives would be limited to taxpayers who itemize, and higher-income taxpayers would still be subject to the additional reduction in the total value of certain deductions after 2025.

Effects on the Budget

The first alternative would increase revenues by $176 billion from 2019 through 2028, the staff of the Joint Committee on Taxation (JCT) estimates. The second alternative would increase revenues by $146 billion over that period, according to JCT. Under both alternatives, the increase in revenues would be larger after the expansion of the standard deduction and decrease in statutory individual income tax rates under the 2017 tax act expire. Following the decrease in the standard deduction, more taxpayers will itemize deductions instead of claiming the standard deduction; as a result, either alternative would affect more taxpayers. Higher tax rates will also increase the value of itemized deductions.

The estimates incorporate taxpayers' responses to the two alternatives. Taxpayers would alter their charitable donations because of the changes in those donations' deductibility. Under the first alternative, people who contribute less than 2 percent of their AGI would no longer have a tax incentive to donate, and many of them would reduce their contributions. That alternative would also encourage taxpayers who had planned to make gifts over several years to combine donations in a single tax year to qualify for the deduction. Under the second alternative, a taxpayer would have less incentive to make in-kind contributions, though taxpayers could sell the items they would have donated and donate the proceeds. (Sales of capital assets would, however, be subject to the capital gains tax.) Those responses make the estimated increase in revenues under either alternative smaller than it would be otherwise.

The estimates are uncertain for two key reasons. First, the estimates rely on CBO's 10-year projections of the economy and individual income under current law. Those projections are inherently uncertain, but they are particularly uncertain because they reflect recently enacted changes to the tax system by the 2017 tax act. Second, the effects of either alternative would depend on how taxpayers altered their charitable giving in response to the increased after-tax cost of giving. The estimates are based on how taxpayers have responded to prior changes in the after-tax cost of giving, which may differ from the response to the changes considered here.

Other Effects

An argument in favor of this option is that, even if they could not be deducted, a significant share of charitable donations would probably still be made. Therefore, allowing taxpayers to deduct charitable contributions is economically inefficient because it results in a large loss of federal revenues for a very small increase in charitable giving. People who make small donations are often less responsive to the tax incentive to make charitable contributions than people who make large contributions. For taxpayers who contribute more than 2 percent of their AGI to charity, the first alternative would maintain the current tax incentive to increase their donations but at much less cost to the federal government. And because most charitable contributions are made in cash, the second alternative would largely maintain the incentive to make donations.

Another advantage of this option is that it would simplify the tax code. Limiting the deduction to contributions in excess of 2 percent of AGI would match the treatment of unreimbursed employee expenses, such as job-related travel costs and union dues, that applied in the past and will apply again after 2025. The option would also increase tax compliance. Deductions of smaller contributions—those amounting to less than $250—are more likely to be erroneous because they do not require the same degree of documentation as deductions of larger contributions. Moreover, the value of in-kind contributions may be overvalued by taxpayers and is difficult for the government to verify.

A disadvantage of this option is that it would cause charitable giving to decline, albeit by only a small amount, JCT and CBO estimate. Although people who make larger donations would still have an incentive to give under the first alternative, they would have slightly lower after-tax income because of the smaller deduction and therefore might reduce their contributions (although by a lesser percentage than people making smaller donations). Under the second alternative, taxpayers would have less incentive to donate goods and services. Taxpayers might consequently shift away from making those types of donations, even if charitable organizations would prefer in-kind donations instead of cash.