Why Trump’s Tax Plan May Not Ultimately Reduce Charitable Giving

January 4, 2018 | By: Kari Brummond, EA

trump tax plan and charitable givingThere’s a lot of speculation about what’s going to happen with Trump’s tax plan or the “Tax Cuts and Jobs Act.” Many people are panicking or rejoicing without looking at the details, and others are narrowing in on a single aspect of the plan while ignoring the rest. In particular, many people are afraid charitable giving may drop as a result of the new tax regulations.

Projected Effects on Charitable Giving

In some ways, the new tax plan makes it more expensive to give. That is due to a drop in the highest marginal tax rate coupled with an increase in the standard deduction. Due to these changes, the Tax Policy Center argues that the average cost of giving $100 is going to increase from $79.20 to $91.30. For households in the top one percent, these analysts project that the average price of donating $100 may increase from $67.70 to $94.30.

How Tax Brackets Affect the Cost of Donations

To explain how tax rates affect charitable giving, imagine someone with income in the top tax bracket donates $100. Under the current tax system, the highest tax rate is 39.6 percent. Based on that tax rate, if someone gives $100 to a qualified charity, they save $39.60 in income tax, and that makes the cost of the donation only $60.40. Under the new tax plan, the highest marginal tax rate drops to 37 percent, making a gift of $100 bucks cost $63.

It’s doubtful that $2.40 is going to convince people to stop giving. Even on a $1 million donation, that still only makes a $2,400 difference. Arguably, that’s not enough of a difference to change behavior and reduce charitable giving. Note this example doesn’t take into account the effects created by the change in the standard deduction. It only accounts for tax bracket changes.

Clustering Donations and Donor-Advised Funds

To make up for the differences in tax benefits, many people may start clustering their donations. Clustering means that instead of giving the same amount every year, taxpayers may donate every two or three years so they can reap the most significant tax benefits.

Some charities worry about the effects of a staggered giving schedule. To smooth out the flow of funds to charity, many taxpayers may turn to donor-advised funds (DAF). DAFs have been around since the 1930s. Their popularity began to grow in the 1990s, and now, three percent of charitable donations flow through these funds.

In 2016, there were 285,000 donor-advised funds, an increase of 7 percent over the previous year. The value of the top 85 DAFs tripled from 2008 to 2013. This growth is expected to continue even more strongly under the new tax plan.

The Standard Deduction Effect on Charitable Giving

Under the new tax plan, the standard deduction is also increasing, and this too may impact charitable giving. Currently, the standard deduction is $6,350 for singles and $12,700 for people who are married filing jointly. Under the new tax plan, the standard deduction increases to $12,000 and $24,000, respectively. Justin Trudeau loving liberals should enjoy this development as it puts the standard deduction of the United States much closer to Canada’s.

In the U.S., you have a choice between taking the standard deduction and itemizing your deductions. In a nutshell, you add up all your itemized deductions, and if they exceed the standard deduction, you take that amount. If the total of your itemized deductions is less than the standard, you claim the standard deduction. This amount gets subtracted from your total income to determine how much of your income is taxable.

To illustrate how this shift may affect donations, imagine you are a married couple (filing jointly) with $10,000 in mortgage interest, $2,000 in charitable giving, and another $2,000 in qualifying medical expenses or other random deductions. That adds up to $14,000. Under the old plan, the $14,000 exceeds your standard deduction, so you itemize. Under the new bill, however, that amount is considerably less than the standard deduction. Rather than claiming $14,000 in itemized deductions, you just take the $24,000 standard deduction.

Some analysts think removing the tax incentive will make people less likely to donate. However, this perspective doesn’t take into account that thanks to the increased standard deduction, this hypothetical couple now has an extra $10,000 in deductions. That reduces their tax liability, and arguably, they may use some of that extra money to donate to charity.

The Connection Between Itemizing and Giving

While there’s a lot of panicked chatter around changes to itemizing, itemization isn’t as popular as many people think. Under the current tax plan, less than a third of tax filers itemize, and the remaining 70 percent take the standard deduction. Under the new tax plan, only 10 percent of taxpayers are expected to itemize deductions.

Currently, taxpayers who itemize donate an average of $4790 per year, and that amount fluctuates a lot depending on their income levels. Itemizers with incomes between $25,000 and $50,000 donate an average of $2,594, while those with incomes over $2 million, give an average of $383,953 per year.

These itemizers account for 82 percent of the $239 billion donated to charity each year.  The remaining 18 percent comes from people who don’t itemize. At first glance, this distribution implies that people who itemize are more likely to give. However, when you dig a little deeper, the numbers tell a different story. Take a look.

Although some low-income taxpayers itemize, there is a direct correlation between income levels and itemization rates. While only 6 percent of taxpayers with incomes under $25,000 itemize, 78.8 percent of people who earn between $100,000 and $200,000 itemize and 93.5 percent of people who make over $200,000 itemize. In other words, the more someone makes, the more likely they are to itemize.

Keep in mind regarding wealth distribution in America, people in the top 10 percent hold 76 percent of the country’s wealth. Statistically, these people are incredibly likely to itemize, and this begs the questions are these taxpayers responsible for the majority of the country’s donations because they itemize or because they have the majority of the money to donate in the first place? Analysts who are worried about donations falling are staking their beliefs on the idea that these people give because they itemize.  However, maybe these people make the majority of the country’s charitable gifts because they have the majority of the country’s wealth.

However, people who don’t itemize and who don’t have a lot of money still give, regardless of the fact that they don’t gain a tax advantage for doing so. According to some estimates, people earning under $100,000, donate 3.6 percent of their income to charity every year, whether they itemize or not.

A lot of people give in small amounts. They drop change into donation buckets, or they text $10 or $20 for disaster relief funds. They may even set up small donations to come out of their checking account every month. For example, Bernie Sanders’ campaign raised about $231 million with an average donation of less than $30. It is one example of how small contributions can make a big impact—many other charities also rely on small donations.

Reducing the Estate Tax

In addition to the above changes, the new tax plan phases out the estate plan over the next six years. Currently, couples pay a 40 percent estate tax on estates worth over $10.98 million, with the tax only applying to amounts over that threshold. Many couples donate strategically throughout their lifetimes to reduce how much money they pay in taxes after death,

People also assume that people won’t’ give if they aren’t worried about the estate tax. This faulty argument rests on the idea that the wealthy only donate to save money on their taxes. That just isn’t true, either currently or historically.

The modern estate tax has only existed since 1916, but giving has been an American tradition since long before that. Notably, Cornelius Vanderbilt endowed the Vanderbilt University with a million dollars in 1873. The Rockefeller Foundation was founded in 1913, and the Carnegie Foundation was started in 1905. None of these endowments were created to avoid the estate tax because it didn’t exist then.

Presumably, if the estate tax doesn’t exist in the future, people with wealth will have more money to give away. In that same vein, Bill Gates and Warren Buffett’s Giving Pledge encourages billionaires to commit to giving the majority of their wealth to philanthropic causes.  Arguably, initiatives like this increase giving, regardless of tax incentives.

Corporate Tax Cut and the Effect on Giving

Lowering the corporate tax rate may also result in more donations. Currently, small businesses donate 6 percent of their profits on average. With lower corporate tax rates and rising demand for corporate social responsibility, many companies may decide to give more.

Beyond the Numbers

When trying to predict social trends, it is essential to look at legislation, but culture can be even stronger. The United States has a philanthropic spirit, and on a cultural level, there’s long been a push toward charitable giving. Americans donate about seven times more than Europeans, per capita, and they make twice the volume of donations of Canadians.

To put it just, people may adjust their giving schedules, but they aren’t going to stop giving due to Trump’s tax plan.