The justification for charitable tax breaks

The Government’s recent White Paper on giving and the “call to arms” issued by the Philanthropy Review have made the debate around what can be done to encourage charitable giving current once again. One of the main questions in this debate is always “what can the government do?” To which the answer is usually: “give us more tax incentives!” However, with the economic situation as it is, the Government (and the Treasury in particular) are understandably reluctant to give away more revenue in the form of tax reliefs for giving, so it is increasingly difficult to make this demand.

Rather than focusing on the specifics of particular tax measures that could be introduced and their potential cost/benefit, which is what those of us working in voluntary sector policy seem to end up doing most of the time, I thought I would take the opportunity in this blog post to look at the bigger picture.

We often take it for granted that charitable gifts receive tax relief, without stopping to think through exactly why this should be the case. If we look at what the underlying arguments for charitable tax relief actually are, it can help us to understand what the justification might be for introducing new reliefs and how best to design these.

Rather than try and reinvent the wheel (or claim that I have!), I am going to rely heavily on a great paper on this subject by Rob Reich of Stanford University. (You can read an early draft of this article for free here, or find the final version in this volume). In this paper, Reich identifies three possible justifications for charitable tax deductions, the merits of each of which he then goes on to examine. These are:

1) The Tax Base Rationale: This argues that tax deductions for charitable giving are not really tax “breaks” at all, because you need to deduct any charitable gifts from an individual’s income in order to properly define what they should be taxed on. The reasoning underpinning this is that people should only be taxed on personal consumption or wealth accumulation, and money given away to charity does not count as either.

2) The Subsidy Rationale: This argues that it is appropriate for the State to offer tax breaks for people to be charitable because by doing so it stimulates greater social value than it could have produced on its own. The underlying reasoning here is that the State collects taxes in order to pay for public or social goods, and that charities and civil society organisations work to produce these same goods. Hence it is fair and efficient to allow people to choose to contribute to social good directly through charitable gifts rather than through paying their taxes.

3) The Pluralism Rationale: This argues that rather than justifying the tax break because of any specific social good produced by a particular charitable gift, it should be justified more broadly on the basis that there is inherent value to society in having a thriving charitable sector. I.e. the public good is civil society itself. Hence any decent liberal democracy should support the ongoing health of civil society by offering tax breaks to those who want to contribute to it.

Reich argues that points 1) and 2) are not valid justifications. I will not go into all the details here, although you should definitely check the full article out, as the arguments are really interesting!

In brief, the Tax Base rationale is rejected for a number of reasons, the most basic of which is the fact that it is false to distinguish between discretionary spending and charitable giving because for many people, what they choose to do with their money is give it to charity, in the same way that other people choose to spend it on consumer goods.

The rejection of the subsidy rationale is more interesting. As Reich notes, “what’s obvious about the subsidy rationale is that it shifts attention from the fair treatment of the donor to the recipient of the donation and the good that is done with the gift.” What becomes apparent when you do this is that while civil society organisations may be producing social goods that are also valued by the State, the diversity of their missions and operations means that they are achieving a whole load of other social goods that are not necessarily aims shared by the State. Hence for the State to forego tax revenue in order to support these aims is not justifiable.

The upshot of this is that we cannot justify a tax break for charitable giving on the basis that it is a subsidy for the production of social goods unless we can be confident that those goods would have had to be produced through public spending otherwise. One way to think about this is to imagine that we got rid of taxation and public spending, and instead relied upon philanthropy and the work of civil society organisations to address the needs of society. The question then is: would the landscape of services look the same as what we have now? There is obviously no way to be certain, as this is a counterfactual, but there are certainly reasons to be doubtful. The main one is that if we compare the profile of public spending with that of philanthropic spending, the balance of where money goes is very different.

In particular, we are often warned of the dangers of a “plutocratic bias” in philanthropy, whereby money disproportionately goes to beneficiaries that are in areas favoured by rich people. (e.g. culture, heritage, medical causes). Of course, we need to be careful to take into account that all current philanthropic spending is done against the backdrop of State provision, and that if this provision were suddenly removed people might start giving in considerably different ways. (In fact many more hawkish right-wingers- particularly those who fetishise the “golden age of Victorian philanthropy”- argue that this is essentially what we should do: cut taxes, cut public spending and trust philanthropy to fill the void. Thankfully no one has listened to them. Yet…)

This means that the only reasonable justification for the government to offer charitable tax breaks is as a way to support the general health of civil society. What does this mean for us in practical terms?

Well, to my mind it provides a useful yardstick against which to measure existing tax relief mechanisms, or any proposed new ones. The first question we ask should always be “does this tax incentive contribute to the health of civil society?” This may seem like an incredibly obvious point, but it can throw up some interesting issues. For instance when considering mechanisms where the tax relief benefits the charity directly versus those where the direct benefit is to the donor. In the former case, the benefit to civil society is clear- there is immediately more money in the hands of charities. In the latter case, however, since the tax relief cannot be justified on the basis of an argument about the fair treatment of donors, we have to look at whether it provides a real incentive for people to give (or give more). If there is no evidence that it does, then the loss of tax income cannot be justified on the basis that the State is subsiding the health of civil society.

I will consider some of the practical implications of this analysis in further detail in future posts. Stay tuned!

Rhodri Davies

2 responses to “The justification for charitable tax breaks

  1. Pingback: Cambodian government to join the list of governments cracking down on civil society | Future World Giving·

  2. Pingback: Closing Space or Open Season? What President Trump’s latest move means for the future of civil society campaigning | Giving Thought·

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