Tag: charitable contributions

Categories
books estate tax income tax

Books I’ve Read Recently – The Second Estate

This is another in my series of bad high school book reports on selected nonfiction books that I have read recently. I write them to memorialize my thoughts in the vain hope that I will remember a bit more of what I read.

Author and book

Ray D. Madoff, The Second Estate How the Tax Code Made an American Aristocracy (U of Chicago Press 2025).

Madoff is a tax professor at Boston College Law School. I have read some of her law review articles over the years. One of her areas of expertise is the tax law’s intersection with charities and nonprofits. (I put her up there with Roger Colinvaux and Ellen Aprill as top experts on that topic.) Until I read blurbs for this book, I did not realize that estate tax and planning was also an area of her expertise. That jibes with her interest in charities, since charitable giving is a key part of estate planning for the uber wealthy.

The title derives from the nomenclature of France’s ancien regime. The Second Estate1 was the aristocracy, which famously paid little to no tax, shifting that burden to the third estate, the general populace. Some consider that to be a main cause of the French Revolution (well, economic and social inequality might be a broader formulation). Hence, the old French saw: “The nobles fight; the clergy pray and the people pay” and the subtitle and subtext of the book – that America’s tax system has created a sort of aristocracy of the ultra-wealthy by lightly taxing them.

Why I read it

I was interested in the book both because of my favorable view of Madoff’s work and the book’s topic – an attempt at an accessible overview of what has happened to the federal income and estate taxes over the last 50 years.2 

The more specific trigger was I knew that Madoff was doing a book event at my youngest daughter’s workplace, The Center for Brooklyn History. So, I asked her to buy a copy for me at the event, which she did, got Madoff to sign, and brought to me when she came home for Thanksgiving.

What I found interesting

Basic thesis. Madoff’s book is (to be honest) an advocacy piece to convince a reader with little to no tax background that:

  • The federal tax system since the 1980s has become much more regressive, tilted to the rich/affluent as a result of systematic Congressional tax cuts and its inattention to closing loopholes as they have been developed.
  • This results mainly from lower rates on realized income from capital and, more importantly, much income of the wealthy never being taxed at all.
  • The net effect is to materially cut federal revenues and is a big part of the nation’s fiscal problems.
  • Her reform ideas would go a long way to fixing this.

Description of how this occurred

Most of the book (all but the last chapter) is her description of how this occurred. It’s a familiar narrative for someone steeped in tax policy and she does a nice job of making it understandable to an interested, intelligent general reader.

To simplify her account, the avoidance strategies flow from various combinations of the income tax’s realization requirement (sale or exchange of an asset is needed to trigger income), stepped-up basis (capital gain tax excused by the owner’s death), allowance of share buy-backs, and the ability of business owners to characterize their labor income as income from capital. Those features enable the Buy, Borrow, and Die avoidance structure that slips the grasp of both the income and employment taxes.3 Much business and labor income becomes capital gain that is deferred until death and then, forgiven.

That leaves the estate and gift taxes, which are avoided by the ultrarich with a combination of a variety of valuation dodges (the book does not discuss this much, a failing I think), charitable giving that too often does not yield public benefits comparable to the tax avoided, and other measures.

The book provides narratives of both the tax avoidance playbook (as she puts it) and some of the legislative changes that enabled those strategies. The strongest chapter – not surprisingly, I guess, given her academic focus – is the chapter on philanthropy. (It has more detail and seems more evenhanded by discussing a bit more of the policy rationales for the overly generous – in her and my views – tax benefits and why they’re invalid.)

Three of the many nuggets in her account that I found interesting:

  • 121 of the people on the Forbes 400 list inherited their fortunes.4 The Forbes 400 is an inexact measure of wealth. As I have noted before, it likely misses a lot of the top people. That does not lessen Madoff’s basic point that inherited wealth is a very big deal and it undercuts the policy argument that low taxes are essential to incent risk taking and work by the wealthy. That general point has never made sense to me.5
  • Julius Rosenwald, whose fortune derived from Sears, built nearly 5,000 schools in the South in the early 20th century. I was completely unaware of this guy and his efforts. P. 147.
  • The dramatic rise in the amounts of charitable contributions to private foundations and donor advised funds (rising from 6% in 1993 to 41% in 2023). I knew it had gone up quite a bit, but not sevenfold. P. 142.

Her fix

The book’s last chapter describes her reform ideas, which consist of three basic parts:

  • Repeal the estate tax and tax inheritances and gifts to the recipients instead under the income tax.6
  • Raise the tax on investment and property income. The key component is to tax capital gains at death. She doesn’t say, but I assume she would also eliminate the lower rates for realized capital gains and dividends, as well as the various dodges that recharacterize labor compensation as investment income (e.g., carried interest).
  • Reform the tax treatment of contributions to charities.

All these changes make policy sense to me, although I could imagine alternatives that would augment her changes.7 Much of her perceived advantages are on the perception end of things (e.g., taxing inheritances and gifts under the income tax rather than transfer taxes).

What disappointed me

The book is essentially an advocacy piece. In that sense, it reads more like a legal brief than an academic article. I had the uneasy feeling it was constructed to make as strong a case as possible and did not engage enough with the countervailing arguments and rationales. That would have made a longer and more complex book that would have much less appeal to her perceived audience. At least, I assume that was her thinking.8

One irritation to me was that in the preface (p. xiv), Madoff implicitly teases the idea that doing a better job of taxing the very rich can solve (or maybe mostly solve) the federal “fiscal crisis” (her term, but I wholly agree). In her words:

A frequent refrain is that taxing the rich wouldn’t make much of a difference in this. But the top-line numbers of the federal budget show that claim to be without merit. p. xiv (end notes omitted).

Given that tease, I assumed the book, at some point, was going to address this issue, at least in broad terms. Roughly how much of the fiscal problem would be fixed by Madoff’s proposed solutions? It never does.9 That was a disappointment, since I regard the ever-growing budget deficit is one of the big fiscal challenges the country faces. I get that revenue estimating is outside of her expertise; she’s not an economist. But she could have attempted to assemble estimates prepared by JCT, CBO, TPC, etc. to at least give an impression of how much could be raised by her proposed changes. One problem is that they are stated in such general terms that it would be impossible to put numbers on them.

I think a principal reason why Madoff wrote the book is that she perceives that progressive advocates (members of Congress, staffers, think tank types, etc.) of taxing the rich have simply not done a very good job both in designing their policy proposals or in explaining and advocating for them. The book is her attempt to show them the way.

A key part of that is her thinking is to emphasize inheritances are income by taxing them directly that way, while making it utterly clear that they have never been taxed as income either to those who originally earn them or inherited them (thanks to stepped basis). Count me skeptical as to whether that will move the political acceptability needle or not. Polling, focus group, or psychological lab testing data would help (nothing that law profs do typically, though).

Some niggling reactions:

  • One of her assertions is that Congress’s failure to pay attention to the tax avoidance machine and to regularly enact technical correction bills and to close developing gaps is a major cause of the problems. I think that is absolutely the case, since the late 1980s. A chapter with details devoted to that reality would have been nice.
  • The book glosses over technical details to keep the account brief and assessable (I assume). I understand that but was puzzled by some apparent simplifications. For example, she regularly refers to the top capital gains tax rate as 20%. Since the NIIT applies to capital gain income, the effective rate is really 23.8%. To be fair, she is consistent and her use of the 20% rate reduces the implicit subsidy for charitable contributions (avoiding capital gain and estate taxes + subsidy for reduction of ordinary income through deducting FMV of contributed property), which she also refers to as being too high. So, it’s not like she’s fudging the numbers to favor her message.
  • What’s missing from her reform agenda IMO is shoring up the FICA/SECA tax system – in particular, S corp and limited partnership distributions, as well as better indexing10 or eliminating the ceiling on the portion of tax funding OASDI benefits. I get why she did not discuss this. It doesn’t fit generally with her narrative that the problem is the under taxation of investment income and inheritances and that analyses of tax burdens too often ignore the payroll taxes (i.e., FICA and SECA).
  • The book does not mention the burgeoning use of Exchange Traded Funds or ETFs, which I think are eroding the tax on mutual fund capital gain income. This affects the mass affluent more than the billionaire class who seem to be the focus of her ire. I still think it is slowly (or not so slowly) blowing a hole in the tax base and primarily benefiting the affluent although not the top 0.01%. I would stop treating them differently than traditional mutual funds.

SALT connection

The national erosion of the tax base, enacted and/or abated by Congress, filters down to state and local taxation. However, the structure of the breaks that Congress has given to capital gains and dividends – in the form of alternative lower tax rates – typically does not affect states tax bases. For example, Minnesota continues to tax capital gain and dividend income at the same rate as ordinary income. Many other states (notably CA) do so as well.

But the bigger part of Madoff’s narrative – the conversion of corporate profits and business earnings into capital gain that is deferred until realized and ultimately forgiven at death for bequests (Buy, Borrow, and Die) does affect state tax bases. All state income taxes (to my knowledge) follow the federal rule and step up basis at death. The campaign against and resulting erosion of the federal estate tax – plus EGTRA’s repeal of the federal credit for state estate and inheritance taxes – accentuated the effect on state tax bases. It has caused two-thirds of states (33) to repeal their estate and/or inheritance taxes.

So, Madoff’s story is very much also a SALT story, although she does not delve into or mention that.

My Take

I’m sympathetic to Madoff’s thesis but skeptical of just how central taxes are to the socio-economic changes in American society that have occurred from the end of the New Deal Era (roughly sometime in the late 1970s) to now, the rise inequality and particularly the growth in the very top’s share of wealth and income. Tax changes over the last 40+ years have certainly reduced the system’s progressivity but it remains progressive.

I suspect that it is more a story of cultural change and social acceptance of a winner-take-most society that started to take hold in the 1970s. Malaise (Jimmy Carter’s word) over stagflation made the nation susceptible to the philosophy of Reagan/Friedman/Mont Pelerin Society.11 This philosophical shift enabled shareholders and top management to appropriate more corporate profits with a lesser share for ordinary employees (remember the “Greed is Good” narrative of the 1980s that would have been verboten during the 1930s to the 1960s), sidelining of unions, reducing antitrust enforcement, and similar. All of these are mainly non-tax stories. Tax was a factor. I just don’t think it was the or the most important factor.

Similarly, America’s tax system continues to be significantly more progressive than Europe’s, which follows a model of much higher overall taxation that is less progressive (heavy reliance on consumption taxation through VATs) but funds a more generous social safety net. Europe’s rise in income and wealth inequality has been much more modest. I tend to think their model works better. Even though America’s economic growth has been more robust, way too much of it has gone to the top and I’m skeptical how much of America’s growth is really attributable to taxing the rich at low rates.

Over the last dozen years, the US has seen a rise in the share that pre-tax corporate profits comprise of GDP with declines in the similar share of employee compensation. See the graph that I extracted from Fred below. Before 2006, pretax corporate profits (solid blue line, right axis) were consistently below 14%, typically a lot below. Since the end of the Great Recession, they are well above that. The employee compensation share (dashed green line) moves inversely to the profit share. That means they’ve been quite a bit lower over the last years – more of return is going to capital and less to ordinary workers. Interestingly, that was not the case in the 1980s and 1990s.

There is empirical evidence that top management is capturing more of the employee compensation share of corporate revenues, including part of the reduction in corporate taxes (but that does not affect the blue line in the graph which is pretax). The classic case is the dramatic rise in the ratio of CEO to average worker compensation. From Wikipedia:

[A]n April 2013 study by Bloomberg finds that large public company CEOs were paid an average of 204 times the compensation of rank-and-file workers in their industries. By comparison, it is estimated that the average CEO Pay Ratio was about 20 times the typical worker’s pay in the 1950s, with that multiple rising to 42-to-1 in 1980, and to 120-to-1 in 2000.

That these shifts were caused mainly by tax changes seem dubious to me. More likely, I would guess they were due to a vector of social and cultural variables. It’s too easy for those of us who spend most of our professional lives studying taxes and tax policy to overemphasize their importance. I suspect that Professor Madoff has fallen a bit into that trap.

That said, a very progressive tax system (like the fixes that Madoff suggests) would reduce inequality and provide material revenue to fund our current social safety (i.e., reduce the deficit) or expand it. However, I tend to think that taxing income to fund redistribution it is harder to do social-politically than creating a culture of social norms against a winner-take-most system.

The latter is what America had in the decades after the Great Depression. It meant that unions were stronger and social norms encouraged allocating more of business revenues to ordinary workers and less to shareholders and top management. Obviously, this is all pure speculation, and I think both sets of changes go hand-in-hand: the progressive tax fixes will only occur with changes in social norms. That said, I do think that a robust consumption tax system (i.e., a VAT) is necessary to provide a European style social safety net. I’m more persuaded by another tax academic, Ed Kleinbard, who wrote accessible books on this topic than Madoff, at least WRT to big fiscal fixes.

Notes

  1. First estate was the clergy; third, more or less everyone else. Later, the fourth became the press. ↩︎
  2. Many of her views align with mine. To wit: the overall sweep of federal tax changes over the last 50 years is characterized by a dramatic reduction in the taxation of capital income, employment compensation of high-income earners, and wealth transfers. WRT the reduction in tax on capital income, this graph per Gene Steuerle says a lot.
    I try to resist simply reading stuff that I know will largely confirm my priors, regarding it as enabling a lazy mind and wasting my time, but the book was short (>200 pp) and I’m always curious about how technical experts attempt to communicate with the nonexpert public on tax policy and law. ↩︎
  3. Lifetime consumption financed by borrowing also avoids the estate tax, because the debt incurred reduces the estate’s taxable value. But the uber wealthy do not consume most of their income/net worth, so avoiding the estate tax requires additional measure such as discounting valuations, shifting appreciation in assets to later generations of heirs, creating charitable foundations that really carry out their personal agendas, and similar. ↩︎
  4. There must be some ambiguity as to how to treat heirs who continued to run businesses that increase in size dramatically (i.e., more than an index fund) during their tenures. ↩︎
  5. Higher rates of return, enabled by low taxes, are not necessary to increase their or their heirs’ ability to consume. The fact that a goodly portion of the very wealthy are on a never-ending quest to maintain and build that wealth has always struck me as a matter mainly of relative competition – against each other for status and to create business, social and political power. Social rules (i.e., higher taxes) that disadvantage all of them, more or less equally, will have little effect on the incentive to engage in that sort of competition. ↩︎
  6. My observation: The advantages of this are largely a matter of political acceptability or public perception. Addressing the key weaknesses in the current system – valuation issues and a too big exemption amount – are not fixed by the structural change. Count me skeptical that the difference in perception will matter much. ↩︎
  7. As an aside, I agree with her rejection of a wealth tax as an unnecessary diversion that SCOTUS would almost surely strike down based on what the opinions in Moore revealed. It also has a host of administrative and political acceptability problems. ↩︎
  8. Ed Kleinbaum’s two books are a contrast that I found more satisfying. The problem with his more nuanced and detailed analysis is that Madoff likely considered it less assessable to the broad audience she sought to reach. ↩︎
  9. I omitted two end or footnotes from the quote. Neither of them provides, in my judgment, any support for the statements. They simply cite wealth estimates of the top 1%, not how much income is excluded from the tax base. One mistakenly refers to billions when it must mean trillions, obviously just a typo. ↩︎
  10. A good case can be made that it should be a fixed percentage of overall compensation, not an index of wage increases that is now used. That would capture the increasing tilt of the distribution of labor compensation toward the highest incomes. ↩︎
  11. I think Friedmans’ persuasiveness was an underrated factor. PBS even made a series out of Free Choose. ↩︎
Categories
income tax

More on OBBBA

This post has a few more of my random reflections on OBBBA.1

Table of Contents

  1. Medicaid
    1. Nature of the Cuts
    2. Rhetorical Responses
      1. CBO’s estimates are too high
        1. My take
      2. We can fix them
        1. My take
  2. Littering the tax landscape
    1. Two niche provisions
      1. National Firearms Tax
      2. Income from wagering
    2. Charitable contributions
      1. Non-itemizer deduction
      2. 0.5% AGI floor for individuals
      3. 1% floor for corporations
      4. Contributions to subsistence whaling
      5. SGO tax credit
      6. Missed opportunity
    3. Not GILTI

Medicaid

I blog about taxes and have no expertise in Medicaid, but I can’t let a logical inconsistency in political rhetoric in such a key provision of the bill pass without commenting.

According to the CBO score, the bill will reduce federal spending on Medicaid by almost $1 trillion over ten years (see here, numbers are in Subtitle B, chapter 1 of the Title VII page of the downloadable spreadsheet). If these estimates are remotely close to accurate, this is a very large reduction in the social safety net (by some accounts the largest ever); it will fall heavily on many Trump voters and red states; and Trump campaigned on not cutting Medicaid.2

This situation has led to hand wringing by a few populist type Republicans, presumably because it hurts their base voters and communities.3 By contrast, while Dems are appalled by the potential real-world effects of the cuts, it has them licking their political chops as they plan to make the Medicaid cuts a campaign issue in the midterm and 2028 presidential elections. Whether that will work as a campaign strategy is debatable (see here and here for why it probably won’t), but I’ll do a little amateur analysis of the defenders of the cuts’ rhetorical claims and what I think they reveal about the reality as I see it.

The two main claims that bother me are that the estimated effects of the cuts are wildly overestimated or that because the cuts occur off in the future, they will likely be softened or repealed before they go into effect. If either or some combination of those assertions is correct, then the deficit/debt effects of OBBBA will be even higher. Disassembling about the quality of the estimates and planning future fixes, which you have no plan to pay for, does not change that reality; you can’t have your cake and eat it too.

Nature of the Cuts

Four observations about the Medicaid cuts (again, caveat that this is based on my limited, very high-level understanding of them and Medicaid itself):

First, the cuts largely result from imposing work requirements on able-bodied adults and by capping states’ ability to impose provider taxes that effectively increase the share of program costs paid by the feds. As a very crude explanation of the latter, states “tax” providers while increasing their reimbursements sufficiently to offset the tax. The higher reimbursement holds the provider harmless. Because the feds pay a percentage of the reimbursed tax, this arrangement (“tax”) imposes no cost on the state.4 This is widely recognized as gaming the system but has become engrained as part of the system’s overall mosaic – essentially de facto increasing the federal reimbursement rate. It is also subject to complicated federal regulations that restrict states’ ability to do too much of it (e.g., imposing very high tax rates). OBBBA changes those rules by reducing the allowed tax rate in steps over several years. Somehow, this reduced de facto federal reimbursement rate will need to be made up by states paying more or benefit/eligibility cuts or both.

Second, that structure enables proponents of the cuts to say the changes do not reduce individuals’ benefits. Able-bodied adults, if they aren’t already, can go to work to maintain their benefits. States can stop gaming the system by imposing bogus taxes and pay for the share of the benefits that the statutes nominally say they are responsible for. So, it’s just a choice by beneficiaries and/or state governments, not Congress and the feds. The structure of these changes also makes CBO’s estimating task very difficult, because the change in federal budgetary costs depend upon individual and political behavior that is inherently difficult to predict.

Third, the effective dates of OBBBA’s changes are delayed until after 2026 for the work requirement and after 10/2028 for phasing down the provider tax cap. That is necessary as a practical matter for the work requirement, less so for the tax cap, which could be applied in 2027 as well. That means Congress and/or the administration (by granting waivers or delaying implementation, like the TikTok strategy which ignores a technically binding law SCOTUS has upheld) have time to change their minds about imposing or can mitigate the rules’ effects.

Finally, CBO’s estimated savings from the Medicaid changes are crucial to reducing the bill’s effect on debt – both as a political matter (House passage was mildly in doubt because of objections it increased the debt too much) and as an objective fiscal matter (even nonfiscal hawks are concerned that OBBBA may go too far down a seeming ever-increasing debt path, which is already at a historical high-water mark).

Rhetorical Responses

The primary argument I saw made by the proponents of the Medicaid changes (e.g., Speaker Johnson) argues that they protect the program by ensuring that it only covers what everyone thought it was supposed to cover: i.e., those working or unable to (children, disabled, or elderly) and that states pay their expected (nominal statutory) shares of the program costs. That’s not true other than in their re-formulation of the program’s objectives; it’s what they think, not what the law said. A rough translation: we’re cutting it now, so you don’t have to worry about us cutting it in the future, I guess? It’s a way of saying that is what the program’s parameters should be in their view. Fair enough, but it’s not saying benefits won’t be cut. They will be or CBO’s estimates are wildly wrong. What one thinks about the changes depends upon your policy and political preferences and isn’t of much interest to me (it’s not illogical, just an obtuse way of saying it).

I’m more interested in the arguments made by Republican and conservative types who are concerned (politically or policy-wise) about the changes and argue that they really won’t be that bad. I see basically two flavors of these arguments.

CBO’s estimates are too high

A WaPo column by Ramesh Ponnuru, Why the GOP’s Medicaid cuts are less than meets the eye, is a good example. He doubts the estimates that more than 10 million people will lose coverage5 because of OBBBA:

But the coverage loss from the bill is likely to be a lot smaller than the predictions.

We should keep in mind, first, that the CBO has a poor track record in modeling the effects of health care legislation. * * *

Medicaid estimates, specifically, have been way off. In 2012, after Obamacare had passed and been modified by a Supreme Court ruling, the CBO thought that in 10 years, Medicaid, along with the Children’s Health Insurance Program, would enroll 43 million people. The actual number was more than 87 million, and it had already reached 70 million before the pandemic sent enrollment shooting up.

* * *

The effects of the work requirement are likely to be blunted by state implementation. A CBO assessment last month found that a version of the work requirements would cause a 4.8 million decline in enrollment. Much of the evidence CBO uses, though, comes from a short-lived experiment in Arkansas, a red state that expanded Medicaid reluctantly. Larry Levitt of the health-policy group KFF, drawing on that example, notes that states “could require Medicaid enrollees to report work or exemptions as often as every month.” They could — but will California or New York really be so stringent? Especially when it would lower their federal funding?

My take

Making these estimates is extraordinarily difficult and I am confident that CBO does a competent and neutral job. The obvious difficulties are the complexities of human behavior and specifically political behavior (i.e., what will legislatures and governors do) for which there is little data to provide guidance. Two states, Arkansas and Georgia, have limited and brief experiences with work requirements.6 A large cut in state provider taxes has never been done to my knowledge.7 That means that there is a large confidence interval around these point estimates.

That says nothing about a bias in one or another direction (i.e., over or underestimating the size of the reductions). An underestimate, which is certainly plausible, would make matters worse from the perspective of reducing benefits. Why should we assume, if CBO is bad at making health care program estimates, that they always will be wrong in one direction? If they had consistently erred in one direction, one would expect the analysts to assess why and modify their methods. Ponnuru must not think so. He must think they have a persistent bias in one direction.8

Should we assume that CBO analysts have some sort of inherent bias to overestimating? I can conjure up two reasons why that might be so (likely subconsciously by the relevant analysts):

  • Estimating larger cuts will make their Republican employers happy. Although they’re nonpartisans, Congress is controlled by Republicans and so has more control over CBO. Larger estimated cuts will make the deficit effects of the tax cut smaller and will reduce the need to make more reductions, which would be even less politically palatable. Both things will help Republican leadership put a passable bill together, a good thing for them.
  • If (as the Right always suspects) the analysts involved have policy priors that do not favor the cuts, estimating that they have larger effects will serve those priors. It will allow the program to escape deeper cuts but at the expense of a larger deficit. I’m sure they try hard to avoid explicitly putting their thumb on the scale in that manner, but one’s perception of the world/reality may matter in deciding how much weight to give assumptions for which there is so little data to inform those decisions.

Both factors point toward overestimating the magnitude of the cuts. They are wildly speculative. I’d assign a very low probability to them having meaningful influence on the estimates, but it’s possible.

The key point to keep in mind, which Ponnuru makes to his credit, is that if CBO seriously overestimated the amount of cuts, then the deficit effects of the bill will be much larger. The ship missed the rock but ran into the hard place. Second, the estimates are very large ($988 B), so they need to be off by a lot to matter much in terms of the hardship imposed on recipients and providers. Let’s say they’re too high by 25%, then the cut is ONLY three-quarters of a trillion dollars. Small comfort. In my mind quibbling about estimation accuracy is silly, a false hope, or worse – at least in the way that Ponnuru does it.

We can fix them

As noted above, the Medicaid cuts do not go into effect immediately. That means Congress or the administration can lessen their effects or eliminate some of them altogether. Senator Josh Hawley, one of the GOP populists who opposed the cuts, and Senator Ron Johnson who also opposed them have made this point as a basis voting for OBBBA. Here’s Politico, Ron Johnson believes he will get ‘second bite of the apple’ on Medicaid cuts:

Sen. Ron Johnson (R-Wis.) believes he has a commitment from the White House and Senate GOP leadership to get another chance to repeal an expansion of Medicaid offerings — a controversial proposal that failed to make it the final version of President Donald Trump’s sweeping domestic policy package.

“I think I pretty well have a commitment. They’re going to do that,” Johnson told reporters of the prospects that Republicans will reconsider a provision that would end the federal government’s 90 percent cost share of funding for new enrollees in states that expanded Medicaid under the Democrats’ 2010 health care law.

Here’s NBC on Hawley:

And when asked about the steep Medicaid cuts in the bill, Hawley continued to criticize them. Hawley said his “goal” is to ensure the provider tax changes, which will limit state reimbursement for Medicaid, don’t go into effect in Missouri in 2030 — even as he helped to pass a piece of legislation that will do just that.

My take

There is plenty of time, especially for the provider tax reductions, to modify or mitigate the cuts. As the administrative challenges of implementing them (work requirements) and their social, health, and economic effects become more apparent, changes seem probable. But:

  • Their gargantuan size means making meaningful changes will be extremely expensive and difficult to achieve without materially increasing the debt.
  • Voting for something that you firmly oppose and pledge and/or hope to change (e.g., Hawley, Johnson, and Murkowski) is an odd political strategy, since it gives up your strongest leverage in the legislative process. It must mean that you value some combination of tax cuts and deficit concerns and appeasing Trump and MAGA world more highly than your concerns about the Medicaid cuts.
  • The pattern of structuring payfors (here, Medicaid cuts) in the future and financing the politically desired policy (here, tax cuts) immediately is a time-honored bipartisan tradition. It was done by the Dems with the ACA, delaying implementing some of the tax increases to fund it. That almost inevitably results in unraveling the deficit-mitigating payfors. Republicans and a few Dems joined to repeal key ACA payfors. The medical device tax did go into effect, but was repealed, the Cadillac health coverage tax was repealed before it could be imposed. Some version of that seems likely to happen here unless events intervene (e.g., debt hysteria or crisis). However, there is also a good chance any mitigating factors will be partial or skewed to the politically favored. For example, the rural hospital fund is skewed to red constituencies, as contrast with a more neutral set of criteria that would help any hospital heavily dependent on Medicaid funding or with a high percentage of Medicaid-covered patients, even if it were located in an urban area.
  • The likely bottom line is that the deficit effects of OBBBA are worse than the estimates say, if past political behavior is any guide.

If you doubt that Hawley and others of similar ideological ilk have little have little to no concern about deficits or fiscal responsibility more generally, check out his proposal to rebate tariff revenues.

Littering the tax landscape

OBBBA’s erosion of vertical and horizontal equity is the biggest policy flaw of its tax changes. The distribution of the income tax will be more regressive (although still progressive) and there will be a wider dispersion of tax burdens for households with equal incomes. Both bad and I’m not sure which is worse.

But the more time I spend going through the details, I’m more depressed by how bad the changes are at a granular level, which likely reflects the several decisional dynamics – the hurry with which it was put together, the lack of public scrutiny, and the impetus to throw every Republican member’s (and his or her staffers’) pet ideas into the bill to get their support, grease the skids, etc. The result is an absolute mishmash, a littering of the tax code with provisions with little to no or contradictory policy rationales.

This has serious consequences for the ability of the IRS to administer and enforce the tax law, as well for taxpayers to comply with it. Janet Holtzblatt at TPC points out that OBBBA requires the IRS to issue about a couple dozen new regulations explaining and filling in the gaps at the same time its enforcement budget is being cut. Something has to give with a system that already had higher demands for guidance than resource to provide.

As Holtzblatt points out, the financing dynamics (e.g., paying for private letter rulings and the interests of those suggesting topics for public guidance) already skew the guidance to those with resources or to issues affecting higher-income filers. This does not bode well in terms of clarification of the multiplicity of provisions affecting the masses (beyond the big-ticket items Trump proposed that have already produced a press release from the Service).

To make matters worse, many of these provisions never had hearings or public scrutiny (hello, Trump accounts) and will affect millions. This is a recipe for confusion and unintentional mistakes and noncompliance. Bad.

The Tax Law Center has a new project focused on improving tax administration with a blue-chip set of advisors and contributors. I’m sure they will come up with many sensible ideas with likely little more effect than yelling for the wind and rain to stop.

Two niche provisions

A sprawling bill like OBBBA inevitably contains odd, narrow provisions. Two that I ignored as OBBBA was winding its way through Congress was the effective repeal of the National Firearms Tax and a new limit on deducting gambling losses. Both strike me as peculiar in different ways.

National Firearms Tax

The NFA was enacted in 1934 (allegedly) in response to the St. Valentine’s Day Massacre and the assassination attempt on FDR. It was more regulation (prohibition) than tax in the days when the Lochner Court imposed serious limits on congressional power under the Commerce Clause.9 Imposing a prohibitively high tax was a way to avoid potential limits on regulatory powers. (Second Amendment concerns weren’t much of a consideration in those days.) The tax was/is a flat $200 per item ($4,800 in 2025$) and applies to machine guns, short barrel shotguns (the proverbial sawed-off shotgun, I assume) and rifles, silencers, and similar – weapons and accoutrements Congress wanted to keep off the streets and considered to be criminal tools, rather than legitimate firearms for hunting and protection.

OBBBA’s provision started in the House as an exemption for silencers. The Senate thought that was a good thing and expanded it to exempt everything except machine guns (a bridge too far, I guess). That increased the cost from $1.5 billion in the House bill to $1.7 billion in the Senate bill. Obviously, the tax is mainly being collected on the production of silencers or suppressors. The changes are effective 1/1/2026.

The rationale for repealing this longstanding “tax” is unclear to me. An older CRS report describes proposals to modify the tax on silencers. A case can be made that the tax is unconstitutional now, even though it was upheld back in the 1930s. The Second Amendment doesn’t mean now what it meant then. Congress rarely repeals laws out of a preemptive concern that they may be unconstitutional, especially at a cost of nearly $2 billion, so some sort of pro-gun rationale seems more likely.

This is all new to me. What’s surprised me was how many silencers/suppressors are apparently being sold based on JCT’s revenue estimate. Since the tax is a flat $200/item, the $1.5 billion estimate implies something on the order of 750k silencers will be sold per year. (I would assume a $200 drop in price will stimulate sales FWIW but that is not reflected in estimate of foregone revenue from a repeal I assume.) That’s for items that Congress considered of so little social value (i.e., it was primarily a tool of criminals) in the 1930s that they de facto prohibited their sales.  It’s amazing how attitudes have changed in 90 years.

Income from wagering

OBBBA’s changes in how the income tax applies to gambling are even odder. These changes have attracted a modest amount of attention, including claims by some members who voted for the bill that they were unaware of the changes and by even more members who now want to repeal them.

Deducting gambling losses traditionally have been allowed to offset winnings as a miscellaneous itemized deduction, which (obviously) required itemizing.10 TCJA temporarily eliminated the miscellaneous itemized deduction for casualty losses, but not gambling losses. They continued to be allowed to offset winnings.

OBBBA made TCJA’s disallowance of miscellaneous itemized deductions permanent but added a twist to wagering loss deductibility. It only allows 90% of losses to be deducted. This creates phantom income for someone with net winnings or modest net losses (10% or less). It raises a material amount of tax revenue – $1.1 billion per the JCT estimates for the budget window.

This provision has some very odd and uneven effects. Here are a few:

  • It has no effect on gamblers whose net losses exceed 10% of winnings.
  • A losing gambler with small losses (less than 10% of the amount bet) will have income tax liability, even though she has no income from wagering.
  • For a gambler with winnings, the tax rate effect is higher the lower the return on the amount bet. Put another way, the effective tax rate gets smaller as the return on the amount bet rises. To take an extreme example, it’s meaningless for a lottery winner who pays $5 for a ticket that yields $100,000. By contrast, a high-volume sports bettor who relies on finding bets in which the odds makers are slightly off (essentially playing a narrow margin probability game) will likely be put out of business by the tax. The odds have to be off by a larger amount for her bet to have a positive ROI.
  • The effect also varies depending upon the other taxable income of the gambler. Someone in the top tax bracket pays a bigger tax price obviously than a low-income person. The phantom income is added to and taxed at their marginal rates. As a matter of algebra, the new rule raises the tax cost of making a bet by 0.1% * the taxpayer’s marginal income tax rate.

I can’t come up with a reasonable rationale for such a tax. It makes no sense as a way to impose a sin tax to deter gambling or as a way to impose a tax on the gaming industry to recover some of the social costs of problem gambling. More accurately, many better structures could easily be devised to accomplish policy goals like those. It’s just one of those head scratcher provisions.

I cannot imagine that it will last long, if it ever actually is allowed to go into effect. According to the NBC story linked above, both chairs of the tax writing committees support repeal. (Q: how the heck did this get into the bill, then? Its inclusion is a massive indictment of the process the two chairs used IMO.)

Matt Levine in his interesting and always entertaining daily newsletter, Money Stuff (if you’re interested in corporate finance and don’t scan it everyday, you’re missing out; it’s free), points out that some commodity markets now sell contracts based on the outcomes of sports contests. The CFTC has approved this, surprisingly. Returns on these contracts, functionally indistinguishable from betting on the games, are taxed as capital gains with no restrictions the deductibility of losses from any other capital gains (and $3k/year to reduce ordinary income). This is a big tax advantage, even absent the silly OBBBA provision.

Charitable contributions

OBBBA makes a host of changes in the charitable contribution tax rules. Some of these were likely intended to raise revenues to offset the tax cuts, while others further the GOP policy agenda (credit for contributions to scholarship granting organizations or SGOs) or to mollify interest groups (charities have been lobbying for a nonitemizer deduction for years, more intensely after TCJA’s standard deduction increase). The changes certainly do not simplify or make the incentives easier to understand.

The table below lists the changes for which the JCT published an estimate (negative numbers are tax cuts and positive one’s tax increases). The amounts are for fiscal years 2025-34.

ProvisionRevenues ($B)
Contribution credit – SGOs($25,930)
Nonitemizer deduction(73,750)
0.5% AGI floor for individuals63,107
1% floor for corporations16,603
Alaskan subsistence whaling(3)
Net effect on revenues($19,973)
OBBBA’s charitable contribution changes
Source: JCX-35-25

The overall net effect is a tax reduction of about $20 billion. If one ignores the credit for contributions to scholarship granting organizations (not really a charitable giving incentive since it’s a full offset for amounts given), the net effect is to raise revenues slightly (by about $6 billion).

Not reported in the table is the effect of the increase in the SALT deduction maximum from $10,000 to $40,000. That change will increase the number of itemizers (by about 2 to 4 percentage points according to TPC) who, as a result, will qualify to claim itemized deductions for their charitable contributions. Thus, one of the revenue effects of the higher SALT deduction limit will be more itemizers claiming deductions for their charitable contributions.

Non-itemizer deduction

One of the main criticisms of TCJA’s changes was that its higher standard deductions dramatically limited charitable contribution incentives to a smaller and higher income group of individuals. (TPC has a short piece that describes these effects.) COVID relief legislation allowed a one-year (tax year 2021) deduction for cash contributions by nonitemizers. OBBBA reinstates that deduction and makes it permanent at a higher dollar maximum ($1,000 single/$2,000 married joint versus $300/$600 under the expired provision).

Because of the maximum dollar limit, this is a flawed incentive – it won’t apply to marginal gifts by larger contributors. For larger contributors, it is little more than a modest bonus, a little extra income. But it has a big revenue loss, more than $73 billion.

0.5% AGI floor for individuals

While extending a new benefit to those claiming the standard deduction, OBBBA reduces the benefit for existing itemizers. It does that by disallowing deduction of contributions equal to 0.5% of AGI. This floor will also apply to the new deduction for nonitemizers but will not apply to qualified charitable distributions from traditional IRAs – direct payments made to charities for individuals aged 70.5 years old or older from their IRAs. (At least, that is how I read the law’s language.) This small change increases revenues by over $63 billion, almost totally offsetting the loss attributable to the new deduction for standard deduction filers.

This change has a good policy basis; it makes the incentive more cost effective. Disallowing contributions (scaled to income level) that nearly all contributors would make (w/ or w/o a deduction) minimizes the tax benefits conferred on people for doing what they would do anyway. It focuses the incentive at the critical margin. I have two criticisms, though: (1) the floor should have been set higher (e.g., at 1% or 2%), which would double or triple the savings with little negative incentive effect; (2) the floor should also be applied to qualified charitable distributions from IRAs. The same logic applies in that context and uniform rules are better.11

1% floor for corporations

OBBBA also imposes a 1% taxable income floor on corporate gifts. This raises over $16 billion in revenue.

The logic of this change is similar to the floor for individuals. However, it is worth noting that contributions and advertising/PR spending by businesses are close substitutes. Think of the local retailer sponsoring youth sports or making contributions to get their names listed in arts programs and similar. Those contributions may be motivated by the owners’ charitable impulses or to promote their businesses or more likely a combination of both. The floor will encourage characterizing contributions as ordinary and necessary business expenses. We can expect more “contributions” to be deducted as advertising or promotional expenses. I expect the estimates attempted to take this into account.

Contributions to subsistence whaling

This is one of a suite of minor provisions added at the last minute to secure Senator Murkowski’s decisive vote for the bill.12

SGO tax credit

This is a longstanding GOP desidera, not a charitable contribution incentive but de facto government funding of K-12 private schools since the credit equals 100% of the amount contributed.13 This is, of course, occurred at the same time that direct federal funding of public schools was being withheld and might be cut.

The interesting issue is that states must opt in for contributors to qualify for the credit. How this plays out in blue and purple states (including Minnesota) will be a potentially hot political issue. (A STRIB op-ed has already been published opposing Minnesota opting in.) It essentially pits the lure of “free” federal money for in-state private schools versus a concern that doing so will undercut the viability of public schools.14 It’s roughly mirrors the dilemma red states faced in deciding whether to opt in to the ACA’s expanded Medicaid eligibility rules. That, however, bore no risk of undercutting the existing health care delivery system, so it was more a matter of ideology and perceptions about the risks of future cuts in federal ACA funding, which now are, in fact, looming.

Missed opportunity

Overall, the charitable contribution changes seem positive to me (ignoring the SBO credit). They modestly expand who qualifies for tax incentives, while making the existing incentive slightly more cost effective (thanks to the income floors), with little net change in revenues. But it was a missed opportunity to adopt a universal incentive for all contributors, while cutting back on the overly generous incentives for gifts of appreciated property. The right set of changes could have made the incentives more effective at a lower cost. But in a bill and process of this nature, making hard choices to improve tax policy is expecting too much. The process was too hurried and too partisan to expect much.

Not GILTI

OBBBA revises the international tax rules, including significantly modifying calculation of GILTI. Under prior law, GILTI excluded the normal return (i.e., 10%) from tangible assets, like foreign manufacturing facilities. Very simplistically, 50% of the return above that threshold and 50% of any return from intangible assets were taxable at the regular corporate rate. The 50% deduction was scheduled to drop to 37.5% beginning with tax year 2026, raising the effective federal tax rate on GILTI.

OBBBA eliminates the 10%-exclusion for the return on tangible assets and sets the general exclusion at 40% (rather than allowing it to drop to 37.5%). That means saying goodbye to one of my favorite tax acronyms, GILTI, which I assumed was intentionally concocted to be revealing. The acronym (GILTI = Global Low Taxed Intangible Income) reflected the theory that its inclusion focused on income that was either from intangibles or constituted super-returns on tangible investments (well, 10% might just be above average rather than super), so it roughly reflected income that was artificially shifted to a low-tax foreign country to avoid US tax. Now, 60% of most CFC income will be subject to inclusion. As a result, the reference to “low-taxed income” is gone. The law now refers to it as just net CFC tested income. I don’t know what the consensus acronym will end up being (NCFCTI?).

This will present some interesting issues as to how Minnesota should conform to OBBBA’s changes.15 My instinct is that straightforward conformity (i.e., just updating to the federal changes) would raise revenue, because the effect of increasing 37.5% to 40% will be more than offset by eliminating the 10% threshold for the income from tangibles. However, the JCT spreadsheet does not have the needed detail to see whether that is so. I have a suspicion that fairly significant amounts of new revenue could be involved but have no basis for knowing that. It also depends upon the mix of income of MNCs taxable in Minnesota and their apportionment factors, making a Minnesota estimate slightly more complicated than just allocating the detail from the JCT estimates that JCT typically provides to DOR.

If it is the case that simple conformity would raise material revenues, this should cause the administration and legislators to rethink Minnesota’s very aggressive GILTI tax regime, in my opinion. A few reasons why I think that would be prudent:

First, ITEP has estimates of how much revenue would be raised by mandatory worldwide combined reporting (WWCR). The estimates show that Minnesota’s GILTI regime raises $240 million annually more than WWCR would. WWCR is the basic benchmark for how much a neutral tax apportionment tax regime should raise. (The credible arguments against adopting WWCR are based on administrative, compliance, enforcement, and foreign relations considerations, not theoretical policy.) I have no idea whether the ITEP estimates are accurate (they make quibbles about the possibility they overestimate revenues for GILTI inclusion) but if they are even close, they strongly suggest Minnesota is overtaxing CFC income with its GILTI tax. Conformity to OBBBA would likely make that situation even worse. That combination gives someone like me pause and argues for moderating the tax – i.e., using conformity revenues to somehow cut the tax, not to fund other tax reductions or spending.

Second, there are sure to be constitutional challenges to Minnesota’s GILTI tax. I have tended to discount the probability of their success, but it is certainly not zero or even minimal. The ITEP estimates lend some credibility to opponents’ case.16 (SCOTUS has simply refused to consider the general issue when petitions for cert are filed, as in the Caterpillar case.) Changes in SCOTUS personnel makes assessing the probability more uncertain. Losing a case could be catastrophic fiscally, similar to Cambridge Bank – with the state obligated to pay refunds, plus interest, for many years and for many taxpayers. That is so, because litigation of this type takes forever and many corporations have open audits (tolling the SOLs) or will file for protective refunds.

Third, it’s a certainty that a fair number of corporations will make cases for administrative relief (even more so if simple OBBBA conformity is adopted) because the treatment of GILTI mismeasures the amount of their Minnesota share income. If a MNC would consistently pay less under WWCR, I would think DOR would have difficulty denying relief if only to head off undesirable facts in a constitutional challenge.

One fix would be to add an option for corporations to elect WWCR for an extended period (e.g., 5 or 10 years, so they can’t toggle back and forth based on bad or good years). That would provide a default alternative to 290.20 relief and could be made the rule that would prevail, if the taxation of GILTI is invalidated (deterring constitutional challenges – not sure that passes due process muster?). Of course, if the ITEP estimate is close to accurate, elective WWCR would likely be scored as prohibitively expensive. Reducing the inclusion percentage would be another obvious strategy for mitigating the tax.

NOTES

  1. That is no longer the official popular name of the bill thanks to a successful Democratic point of order. I assume people will ignore that and continue to refer to it as OBBBA. ↩︎
  2. It is worth noting that reducing Medicaid by a trillion dollars (or whatever the real number is) will not reduce health expenditures and consumption by that amount. The consensus based on quality research by health care economists is that the amorphous health care system (hospitals and other providers) still provides services to the uninsured. That occurs, in part, because federal law requires it of hospitals, emergency care providers, etc. It’s just provided at a lesser level of maybe 75% or so of the insured. So, cutting Medicaid dramatically shifts much of the cost elsewhere. This should be viewed as an implicit social tax of uncertain incidence. ↩︎
  3. This characterization by Ross Douthat, a conservative Republican, captures it succinctly: “And it is coalition-shrinking folly for the G.O.P. to persistently cut programs that benefit its own voters while always lightening burdens on wealthier voters who are trending toward the Democrats.” His general point is that the Republicans are policy prisoners of their anti-tax litmus test. Trump ignores the inconsistency with his promise and the reality by falsely denying he’s cutting Medicaid. Simple but not true. ↩︎
  4. A stylized example will illustrate how this works for those who are not familiar with it. Assume a 50% federal match rate. State imposes and collects $2 tax from Hospital for a procedure. State bills the feds for the $2 tax and gets federal reimbursement of $1. State now has $3 = $2 tax + $1 federal reimbursement (it was reimbursed for the procedure’s cost + tax) – and can pay the hospital its previous rate for the procedure + $3 at no cost to the state budget. Hospital is $1 to the good. ↩︎
  5. The media focus tends to be on the number of people losing insurance. It’s also possible that states will cut benefits by reducing reimbursement rates, procedures covered, and similar to offset the dropping cap on provider taxes. ↩︎
  6. The one ACA estimate that CBO muffed by a lot involved the effect of repealing the mandate to purchase insurance in TCJA. In their defense, unlike the work requirement, there was no experience with that to go on: i.e., a policy allowing annual purchase of heavily subsidized individual health insurance without a mandate. They had to rely on a few state examples that involved community-rated individual policies that were not subsidized and with no annual enrollment period. Here, there are the Arkansas and Georgia examples that are very analogous. I think Ponnuru is profoundly unfair to the CBO analysts. Typical for right-wing commentators like him. ↩︎
  7. It’s worth noting that the type of state action matters. For example, if the state offsets $1 of reduced provider taxes with its own source revenue, the feds realize 50 cents of savings and beneficiaries and providers are held harmless. But the state is out the full $1. If the state wants to hold its budget harmless by cutting benefits – either by reducing benefits or by cutting eligibility – it must do so by cutting benefits by at least twice as much because of the federal match (50% is the lowest federal match). The cuts must be bigger for states or beneficiaries (i.e., beneficiaries who were added by the ACA) with higher match rates. For the 90% match rate, that almost surely requires dramatically reducing eligibility. It’s the reverse leverage effect of imposing a provider tax. ↩︎
  8. The two examples Ponnuru uses in his column go in opposite directions, I’d observe. ↩︎
  9. To clear, there’s not much of a tax policy rationale for the tax. Support for it must lie in regulatory considerations and there certainly must be better ways to accomplish such goals than just raising the price by imposing a special tax. But it raises a material amount of revenue when there is a professed concerns about deficits, and spending is being cut to that end with little analysis or thought about benefits relative to costs. ↩︎
  10. Otherwise, allowing losses to reduce unrelated income would subsidize a hobby, personal consumption. If you can truly prove that gambling is your trade or business, losses can be treated as ordinary and necessary business expenses rather than an itemized deduction. This is very difficult to do. For a period, gambling losses could trigger AMT because the miscellaneous itemized deduction was treated as a preference. That was fixed a while back. Its more modest effects caused a lot of gnashing of teeth. ↩︎
  11. Providing special charitable incentives for old people with traditional IRAs makes no policy sense IMO. Disclosure: that is the way I make my cash contributions, since it yields the largest tax savings. ↩︎
  12. It increases an existing limit of $10K to $50k – essentially treating business expenses as a charitable contribution. In certain circumstances, that provides a tax benefit. ↩︎
  13. It’s easy to speculate about why the GOP favors this – antipathy for teachers unions, a core base of the Dems, and/or favoring parochial schools to which more of their supporters send their children. ↩︎
  14. Political fights have erupted in red states, like Texas and Oklahoma, among Republicans over state voucher laws for private schools. ↩︎
  15. Full disclosure: one of the big benefits of retiring was no longer needing to decipher the federal international tax rules and to try and figure out how they affect Minnesota tax and how to recommend conforming Minnesota law to them. The federal rules are technically very complex and the federal and states systems – apportionment versus separate accounting – simply do not lend themselves to meshing nicely. My comments in the text are high level, rank speculation. ↩︎
  16. The conceptual argument for the constitutionality of a state taxing GILTI is that it reflects Congress’s definition (albeit very rough) of CFCs’ income that is really from domestic sources but that MNCs are artificially shifting to their CFCs to minimize federal tax. That federal characterization, then, allows a state to treat it as domestic income (after a dividend haircut) and apply normal domestic apportionment factors. That argument will be harder to sell when a blanket 60% of CFC income is captured, I would think. ↩︎
Categories
income tax

TCJA and charitable contributions

Regular readers know that I’m interested in the effect of tax incentives on charitable giving, as I have blogged about it many times.

TCJA reduced those incentives for many givers by simultaneously raising the standard deduction, while reducing itemized deductions (mainly, SALT and miscellaneous deductions). As a result, fewer taxpayers itemize deduction, the primary method of delivering charitable giving incentives. Before TCJA about 26% of taxpayers itemized, after TCJA about 9% do.
Thus, the price of making charitable contributions went up by the amount of the lost tax benefit for 16% of filers. Well, more accurately the price of alternative consumption went down relative to contributions. For most, the effect equals their marginal tax rate * previously deductible contributions. (More details: TCJA increased the charitable deduction benefits for a few givers by increasing the percentage limit that applies to some contributions. It also reduced marginal rates.)

Given normal supply and demand responses, one would expect that to reduce contributions (higher after-tax price of contributing = lower contributions). The big question is by how much. A cottage industry of economists has undertaken to estimate the effect. A limitation of those analyses so far has been the lack of data. Post-TCJA tax returns don’t report the charitable contributions of taxpayers who switched from itemizing to the standard deduction, so we can’t directly observe how much, if at all, their giving dropped from tax returns. Survey data has limitations but does not suffer from that defect. Good panel survey data (i.e., data with multiple years for the same respondents) with post-TJCA observations is slow in coming out. For example, this 2020 article used pre-TCJA data from the Panel Study of Income Dynamics or PSID (last observation year, 2016) and predicted a significant reduction. PSID is done every other year.

A recently posted NBER working paper, Xiao Han, Daniel M. Hungerman, Mark Ottoni-Wilhel, Tax Incentives for Charitable Giving: New Findings From The TCJA (July 2024), uses one more year of PSID (2018) and so reflects the first year effect of TCJA. Their data is based on about 4,200 PSID respondents who reported their giving (even years) from 2002-18. That’s a good sample size and includes questions on the type of recipient charities. PSID does not capture the top of the income distribution, but those filers tend to be less affected by the TCJA big dollar jump in the standard deduction amounts, since the increases are relatively smaller compared to their incomes.

The study is the most sophisticated that I have seen. I’m not an econometrician and statistics is not my strength, but the study looks to be carefully done. It would be much better to have at least one more year of data to dampen first year timing effects (i.e., some givers made their expected 2018 gifts in 2017 to get one last deduction). The authors use sophisticated statistical techniques and IRS geographic data to adjust for that. I remain modestly skeptical about how effective that is.

As the authors note, TCJA provides an unusual opportunity to estimate the effects of tax incentives because it makes a big change for a large group of taxpayers, unrelated to income or rate changes. The longstanding literature estimating the effects typically had to focus on modest tax rate changes that were confounded by their linkage to the givers’ income levels (higher incomes = higher marginal rates). The literature has wide variations in the estimated effects probably due to those interacting effects.

In any case, the article has interesting findings.

Effect on overall giving

To grossly oversimplify their complicated statistical techniques, the authors use the 2016 giving to project what respondents would have given in 2018 if pre-TCJA tax rules had remained in place and compare that with their reported giving. They found an overall elasticity of 0.8, suggesting that “the foregone tax revenue from the itemization was greater than the fall in giving.” (p. 16). Extrapolating that to the population and comparing it to reported drop in giving in the Giving USA 2020 data:

Our results suggest that essentially the entire observed decline in giving in 2018 can be explained by the TCJA reform. This decline would represent about a 4% decrease in aggregate giving, an effect close to the predictions made in the pre-reform work of Meer and Priday (2020), but more generally on the small end of what was predicted at the time of the reform.

Han, Hungerman, & Ottoni-Wilhe, p. 16.

But recall that the data they are using is for 2018 and that some givers in anticipation of TCJA’s taking effect accelerated their anticipated 2018 charitable gifts into 2017 to preserve their deductibility (retiming gifts, in the authors’ terms). Thus, the above estimate will overstate TCJA’s permanent effect on giving. To adjust for this effect, the authors use IRS data on giving by zip code for 2017 and 2018 and a measurement technique previously developed by others to estimate how much of the drop in giving was due to timing effects. Using IRS data fills in for the fact that the PSID, being done every other year, has no 2017 giving. This method suggests:

[T]hat about 20% of the post-reform drop in giving was retimed to the year before the law’s implementation. Applying this retiming adjustment to the TOT elasticity estimate from the PSID (.8) suggests that the permanent elasticity over all taxpayers in response to TCJA is .6.

Han, Hungerman, & Ottoni-Wilhe, p. 21.

Thus, the total 2018 drop overstates the permanent effect. The 0.6 elasticity, as the authors note, is lower than many of the estimates that were produced when TCJA was under consideration or just after it passed. But it is still a significant effect. For example, it implies a $144 drop for a contributor of $1,000 in the 24% tax bracket who switches from being an itemizer to a standard deduction filer.

Differential effects

Type of charity. One of the interesting elements of the article is that PSID data allows separating out the type of recipient charity. The effects of tax incentives vary along that dimension according to the study:

Giving to religious congregations appears to be relatively insensitive to tax treatment; the estimate is only -$77 and not significant. Instead, the results appear to be driven by giving to all other charitable organizations, and among them, especially by giving to organizations that help people in need.

Han, Hungerman, & Ottoni-Wilhe, p. 12 (footnotes and column references omitted).

Size of contributions and deductions. Not surprisingly, they find that the biggest effects of TCJA’s changes are concentrated among a subset of givers who experience the biggest price effects for their giving. TCJA’s effects are complicated because (as is often the case) there is both a price and an income effect and these offsetting effects vary in size.  The variation is an artifact of the relationship of four factors for a taxpayer: (1) the amount of charitable contributions, (2) total itemized deductions, (3) how many itemized deductions (e.g., SALT) TCJA disallowed, and (4) the increase in the dollar amount of the standard deduction. The differential effects can be illustrated by two extreme examples of filers who switch from itemizing to claiming the standard deduction:

Example 1: All of the taxpayer’s itemized deductions are charitable contributions, and their total amount is just below the new standard deduction. She will experience almost no income effect from the higher standard deduction (i.e., only a tiny tax cut). The price of her contributions will go up by her marginal tax rate relative to other consumption. The authors refer to this as a compensated price increase. Put another way, under the pre-TCJA regime she received a tax benefit because she made charitable contributions. Under TCJA, she can spend that money on travel, entertainment, giving cash to the homeless people on the street (charity but nondeductible), etc. and still pay the same or slightly lower tax.

Example 2: At the other extreme, assume a taxpayer contributes a very small amount (say, a few hundred dollars) and his total itemized deductions are just above the old standard deduction. The higher standard deduction provides a bigger income effect than Example 1, almost all of the increase in the standard deduction provides him a tax cut. Because the charitable contributions were small, the compensated price increase (loss of tax savings of contributing under pre-TCJA law) is a small dollar amount.

The authors find for taxpayers with large income effects (i.e., cases similar to #2) some taxpayers increased their giving (p.  16). But these small effects were overwhelmed by the large negative effects for taxpayers in situations more like #1. Taxpayers with deductions (not just contributions obviously) between $30,000 and $40,000 in contributions showed declines in contributions of about $1,300. Those results are consistent with the predictions of economic theory.

Takeaway

The study provides one more confirmation that TCJA very likely reduced charitable contributions. That effect appears to be more concentrated on charities with missions of helping the poor (e.g., food shelves and similar). By contrast, giving to religious organizations was less or little affected. For those who believe a prime purpose of charitable tax incentives is to lessen the burdens of government, that is a bit troubling. To state the obvious, supporting religion is not a function of government, given the establishment clause of the first amendment. The fact that the negative effect on giving is smaller than many of us expected is the upside.

Categories
income tax

Good Use for MN tax data

Summary

This one of my signature long and boring posts. Now that more than two people appear to be reading my blog, I decided to add a summary so they can move on to something more interesting in 30 seconds or less.

The Tax Policy Center published a report last summer that used Colorado, Minnesota, and New York state tax data to analyze TCJA’s effect on charitable giving. Robert McClelland, Using State-Level Data To Understand How The Tax Cuts And Jobs Act Affected Charitable Contributions, (July 2022) (11 pages); blog post summary. It shows that TCJA did, as expected, reduce charitable giving but the state data shows that the effect is quite a bit smaller than looking at federal tax data alone. Not surprisingly but still useful.

The report showed an unusual effect for two states – the 2018 drop in Minnesota giving was twice as big as in Colorado. I was intrigued and took up the author’s challenge to explore why Minnesota givers appear (probably mistakenly) to be twice as sensitive to tax incentives as Colorado givers. After spending a bunch of time looking for answers and coming up empty, I decided to wait for another year of data. That shows that the effect reversed with Minnesota giving for 2019 increasing quite bit and Colorado giving declining below Minnesota’s new level (measured relative to AGI). I don’t know what is going on, but my best guess (and that’s all it is) is that the 2018 Minnesota data are goofed up (technical term). But I don’t know why or have a good hypothesis for it.

This post is a tedious explanation of what I did, essentially writing up my research notes, a long, tortuous ride that ends in a box canyon with blank walls.

An addendum reprises my previous rants advocating for changes to Minnesota’s tax incentives for charitable giving after TCJA. That won’t happen because of institutional factors in how the legislature makes decisions on stuff like this but I can’t stop myself.

Introduction

TCJA, the 2017 federal tax cut, dramatically reduced the number of taxpayers who qualify for income tax incentives for charitable giving. It did so by simultaneously increasing the standard deduction and cutting back on itemized deductions (mainly for SALT, home equity interest, and employee business expenses). That means many fewer taxpayers now itemize deductions (about 10% versus close to 30% previously nationally), the main way charitable giving federal tax incentives are provided.

These new itemizers experience a higher after-tax price of charitable giving as a result. For example, an itemizer in the 25% bracket could give her favorite charity $1 at an after-tax cost of 75 cents. If she becomes a nonitemizer thanks to TCJA, the price rises to the full dollar contributed. Econ 101 predicts that increasing something’s price reduces the quantity purchased (gifts given here). But TCJA’s tax cuts provided potential givers with more income to make contributions. So, that could cause more giving. As with many tax changes, economic theory does not provide an unambiguous indication of the behavioral response that will occur. Standard contradictory substitution and income effects are at play.

One would expect the substitution effect to be more powerful with big price changes coupled with modest tax cuts. But that and the magnitude are empirical questions.

So far, researchers have relied on survey or federal income tax data. However, charitable contributions by newly nonitemizers will not show up on federal returns even though many still give. You don’t report contributions if you can’t deduct them. Survey data and reporting by nonprofits are less reliable ways to track charitable giving than contributions reported on tax returns. See this AEI Report, Howard Husack, The Tax Cuts and Jobs Act and Charitable Giving by Select High-Income Households (April 2022), for an example of an analysis that relies on income tax data; it assumes (more or less) that a reported decline in deductions equals a decline in charitable giving.

James Chandler, The Effect of the TCJA on Donations to Medical Charities (2021), uses a different type of tax data, contribution reports on Form 990s. Although medical charities (his focus) are required to 990s, a fair number of others (e.g., churches) are not and more importantly the characteristics of donors must be inferred (i.e., they are not reflected in the tax data).

Robert McClelland, a researcher at the Tax Policy Center, came up with a clever way to use state tax data from Colorado, Minnesota, and New York to assess the first-year effects of TCJA on charitable giving. Using State-Level Data To Understand How The Tax Cuts And Jobs Act Affected Charitable Contributions, (July 2022) (11 pages); blog post summary. Because these states continued to allow many of those who no longer itemize federally to deduct contributions for state tax purposes, they provide state tax data on giving behavior by these new nonitemizers. This was such a clever use of Minnesota tax data that I wish I had thought of it.

He found that:

[C]ontributions fell by much less than indicated on federal forms. In Colorado, a 16 percent decline measured at the federal level was in fact a 1 percent decline when contributions on state forms are included. In Minnesota, a 33 percent decline at the federal level was actually an 18 percent decline using combined federal and state data, and in New York, a 15 percent decline at the federal level was more likely a 4 percent decline. However, given 5.6 percent growth in AGI, the decline represents an even higher reduction in the rate of giving. Regardless, residents of these states retained some tax incentive to donate even as they switch from itemizing to not itemizing on their federal forms.

Robert McClelland, Using State-Level Data To Understand How The Tax Cuts And Jobs Act Affected Charitable Contributions, (July 2022), p. 9.

If you’re interested in the effects of TCJA’s changes on charitable giving, I recommend reading McClelland’s report or his blog post. It suggests TCJA’s effects on giving may not be as dire as a growing body of research seems to suggest (Google Scholar has a fair number of papers).

Colorado and Minnesota mystery

As is evident in McClelland’s quote above, the data show a big difference in the effects in Colorado (1% drop) compared to Minnesota (18% drop). McClelland notes:

We are unsure of the reasons for the large disparity between Colorado and Minnesota. State officials may know additional information about reporting incentives in those two years.

Id. p. 8

On the surface, that suggests that Minnesotans are more sensitive to charitable giving tax incentives than Coloradans. That is, TCJA’s tax price increase caused a much bigger decline in Minnesota giving. Both by filers who remain itemizers and by newly nonitemizers. That seems odd. The difference in response is so striking that I thought I would take up McClelland’s challenge.

One year of data for two states is a small sample, so I waited until the two states posted another year of data (2019 in addition to 2018) figuring that might help clarify matters. Instead, it reversed the effect, deepening the mystery. Colorado’s 2019 reported giving dipped, while Minnesota’s increased.

The rest of this post records my efforts. The short answer is that I don’t have a good explanation. But that won’t stop me from droning on about the blind alleys I explored.

Five avenues seemed to me worth exploring:

  • TCJA’s differential effects
  • State data differences
  • State tax law differences
  • Reporting differences
  • Year-to-year variability or state differences in giving patterns

Differential TCJA effects on the two states

The first possibility that I looked at was whether TCJA’s itemized deduction changes affected the states differently. The big difference in itemized deduction amounts (33% drop for MN versus 16% for CO) suggested looking at that possibility. If TCJA caused a significantly higher proportion of Minnesotans to become standard deduction filers than in Colorado, that could account for some of the difference. That is so, because a higher proportion of Minnesotans would be subject to TCJA’s increased price of contributing than Coloradans. The graph shows the percentages of itemizers in Colorado and Minnesota for 2017 through 2020 using data from SOI Historic Table 2 (two more years of SOI data are available than CO and MN data).

It indicates there may be something to this. Pre-TCJA about two percentage points more resident Minnesota filers (35.5%) itemized than Colorado filers (33.6%). TCJA reversed that. In 2018, about two percentage points more resident Colorado filers (13.5%) itemized than Minnesota resident filers (11.3%). The effect persists in 2019 and 2020 (the further declines in 2020 may be pandemic effects).

As an aside, the likely explanation for that effect is that the SALT deduction cap adversely affected Minnesota filers more because of the state’s higher and more progressive taxes, which concentrate burdens on itemizers with their higher incomes. (If TCJA’s SALT cap was designed to punish high tax blue states, as I suggested here, it appears to have worked.) SALT deductions in 2017 were 6.6% of AGI in Minnesota versus on 4.4% in Colorado. Coloradans deducted one percentage point more of their AGI in mortgage interest (largely unaffected by TCJA) than Minnesotans, providing another part of the explanation.

That does mean that TCJA’s price increase for regular Joe and Jane charitable givers hit Minnesota a bit harder.

Another indicator for this effect is the extent to which the two states deviate in the income distribution of their givers. The standard deduction, as a fixed dollar amount, is an easier hurdle for very high income filers to overcome and itemize, all else equal. SOI data for 2017 – 2020 show that higher shares of Colorado itemized deductions for contributions come from high income filers. For tax year 2017 (pre-TCJA), 3.5 percentage points more of Minnesota’s itemized deductions were allowed to filers with AGIs of $100,000 or less, compared with Colorado. Post-TCJA, the difference persisted but dropped to 2.8 percentage points. By contrast, for the 4-year period, 7 percentage points more of Colorado’s itemized deductions were attributable to filers with $1 million or more in AGI than in Minnesota (41% versus 34% for the post TCJA period). The graph shows the latter data.

These effects could explain some of the 2018 difference that McClelland observes, but it has to be a small part of it and not the real explanation. If Minnesota had experienced the same drop as Colorado, it would have resulted in about 87,000 more itemizers, reducing the differences between the two states by maybe 10% to 15%. The fact that Colorado derives proportionately more contributions from higher income givers likely also accounts from some of the difference.

State data differences

Minnesota’s posted data on charitable contributions (i.e., the data used by McClelland) are incomplete because they do not include the contributions deducted as Minnesota itemized deductions. Colorado’s data, by contrast, has no similar omission. That could account for some of the difference. However, the posted Minnesota data also double count some charitable contributions. So, the combined effects could go in the wrong direction.

Undercounts. The data posted on the Minnesota Department of Revenue’s (MDOR) website show charitable contributions claimed on federal Schedule A, which are inferred from the Minnesota income tax sample. (McClelland used SOI numbers which differ because they are derived from the population of returns listing Minnesota addresses filed with the IRS. The SOI amounts differ from the MDOR amounts because of the sample and residency issues. I regard SOI’s numbers as likely more accurate than MDOR’s.) The Minnesota data undercount charitable contributions because they do not include the Minnesota itemized deduction for charitable contributions for filers who take the federal standard deduction but itemize for Minnesota purposes.

Minnesota’s standard deductions amounts equal the federal amounts, but its itemization rules differ. State income taxes are not deductible, while employee business expenses are deductible. Some taxpayers will claim the federal standard deduction but itemize for Minnesota purposes, That occurs when employee business expenses plus their other itemized deductions, other than state income taxes, exceeds the standard deduction. That results in them claiming their charitable contributions as Minnesota itemized deductions, rather than deducting them under the nonitemizer rules. MDOR’s posted data do not report these amounts. I think these amounts are small because for many filers disallowing the income tax deduction will offset allowing employee business expenses.

Overcounts. Conversely, some federal itemizers claim the Minnesota standard deduction and the nonitemizer deduction for charitable contributions. The typical example is a filer whose state income tax deduction is necessary to put them over the standard deduction amount. Thus, for those filers the Minnesota data on the web (either SOI or MDOR) double counts their deductions (the contributions are reported on both Schedule A and as Minnesota nonitemizer deductions). This effect is illustrated by data for the top income strata which show over 106% of returns claimed itemized and non-itemizer charitable contribution deductions, a legal impossibility.

Since I no longer have access to the HITS microsimulation model and income tax sample, I can’t calculate these amounts and I don’t trust my intuition to say even what the sign of the combined change is if these errors were corrected. Thus, this is a blind alley. If I were forced to guess, I would predict the overcounts are more than the undercounts. But I would have little confidence in that guess.

State tax law differences

Another possibility is that some sort of state tax law effect may be responsible. Both states have slightly different charitable giving incentives and differ in their rate structures (flat v. graduated) and bases. There are more similarities than differences, though.

The Colorado and Minnesota legislatures enacted somewhat similar responses to TCJA. Both states had used federal taxable income (FTI) as the starting point for their taxes, thereby incorporating the federal itemized deduction rules, and allowed nonitemizers to deduct charitable contributions. Both responded to TCJA by adopting its higher standard deduction and maintaining their nonitemizer deduction, which now applies to many more filers. Colorado did so under its rolling conformity law; Minnesota by linking to federal AGI but allowing a Minnesota standard deduction equal to TCJA’s and a itemized deduction for contributions following the federal rules.

There are some key differences in the two states’ taxes that may be relevant to charitable contribution behavior:

Rates. Colorado has a flat rate (4.63% in 2017 and 2018), while Minnesota has a graduated rate structure with higher rates (5.35%, 7.05%, 7.85%, and 9.85%). Most of the new non-itemizers after TCJA would be subject to 7.05% and 7.85% Minnesota rates.

Non-itemizer charitable deductions. Both states allow non-itemizers to deduct charitable contributions under similar rules. Contributions over $500 are deductible in computing each state’s taxable income. Colorado allows full deductibility, while Minnesota allows one-half of contributions to be deducted. The incentive effect is determined by multiplying the allowable deduction by applicable marginal tax rates. So, Colorado’s full deductibility offsets its lower tax rate. Of course, what we’re trying to explain is the difference in giving responses in the two states by itemizers that TCJA caused to become standard deduction filers. Thus, the relevant question is whether the combined federal and state changes under TCJA and state conformity for that group had a materially different effect on the after-tax price of giving in the two states. The chart shows the changes.

The graph shows how much TCJA increased the after-tax price of Minnesota and Colorado charitable contribution (expressed in cents per dollar contributed) for a filer who was an itemizer in 2017 and a standard deduction filer in 2018 by levels of AGI. It shows substantial increases in the cost of giving – by about 25 cents/dollar in the sweet spot for these types of givers ($90k to $160k). An increase of that size could be expected to reduce giving, obviously depending upon the elasticity.

But the relevant issue is whether Colorado law did something to mitigate this difference that Minnesota’s law did not. The graph shows that the differences for the two states (the area between the two lines) are small and are unlikely to explain the differences in response in the two states, given any reasonable assumption about elasticity. (The obvious question to me: why was the 2018 decline in Colorado giving so small – only 1% – with the large tax price increase? Standard literature on the elasticity, such as Bakija and Heim, would suggest a larger response. It’s also possible, of course, that 2018 was a particularly good year for charitable giving in Colorado with some very large gifts – for the five tax years I looked at, it had the highest concentration of gifts by resident filers with AGIs of $1 million or more by over 2 percentage points.)

Conservation easement credit. Colorado allows a tax credit for donations of conservation easements. It provides a 50% credit (75% on the first $100,000 of contributed value) – in addition to the deduction under the federal and Colorado state taxes. It has many more complicated rules; it can be partially refundable and can be transferred/sold, for example. This tax expenditure evaluation provides more detail. Minnesota has no comparable incentive. The Colorado credit should stimulate more contributions of conservation easements. This should also result in higher Colorado reported charitable contributions (likely itemized deductions in most cases), since claiming the credit does not appear to disqualify use of the deductions. For 2018 and 2019, Colorado SOI reports $16 million and $14 million in credits claimed respectively, implying about $30 million in value contributed per year. That’s a paltry amount compared to the over $4.6 billion in charitable contributions reported on tax returns by Colorado residents. It’s implausible that it explains the difference between the two states.

Conclusion. It is safe to conclude that state tax law differences do not explain the big difference the 2018 data show. They could explain a very small part of the Colorado advantage, at best.

Reporting differences

This is potential cause that McClelland suggested exploring. 2018 was the first year affected by TCJA’s changes. So, it could have disrupted reporting of contributions on state returns.

Both states responded somewhat similarly to TCJA’s enactment. But the timing of those responses was quite different, and that may have differentially impacted 2018 return filing and taxpayers’ understanding of the applicable rules in the two states. There was a lot more confusion and uncertainty in Minnesota than in Colorado. But it is not obvious why that should lead to different charitable contribution reporting.

Colorado. Colorado is a rolling conformity state. CO Rev Stat § 39-22-103 (5.3) (2018), That means when Congress enacts changes in the federal tax law that affect FTI, those changes automatically apply for Colorado state income tax purposes. Decoupling or failing to follow the federal changes would require the Colorado legislature to enact a law. As a result, when Congress passed TCJA in late December 2017, Colorado taxpayers could be almost certain that its rules would apply to their charitable contributions made in 2018 for both federal and Colorado state income tax purposes. Thus, if TCJA’s standard and itemized deduction changes made them nonitemizers, they would know that they no longer qualified for the federal deduction but would qualify for the Colorado nonitemizer deduction.

Colorado taxpayers, I presume, decided whether or not to make contributions accordingly. They had all year to figure it out, subject to the possibility that the Colorado legislature would make changes. The Colorado forms for 2018 reflected that reality.

Minnesota. If Colorado provided certainty to its filers, Minnesota did the opposite. How the state would respond to the TCJA was still unclear when 2018 filing began.

Minnesota is a fixed conformity state. It links the starting point for its tax (FTI in 2017) to the version of federal law at a fixed date. Minn. Stat. § 290.01, subd. 31. (This is required under a Minnesota Supreme Court decision, which held that a 1960s era rolling conformity statute unconstitutionally delegated legislative power to Congress. Wallace v. Commissioner of Taxation, 184 N.W. 2d 588 (1971).) As a result, how the state would respond to TCJA required legislative action. Minnesota had divided government in 2018 (Democratic governor and Republican legislature), which was unable to agree on a conformity bill during the 2018 legislative session. The legislature did not enact conformity to TCJA until May 2019 after tax year 2018 filing was mostly over.

To make matters worse, Minnesota law required that the election to use itemized deductions or the standard deduction must be made consistently for federal and Minnesota purposes. Minn. Stat. § 290.01, subd. 19 (2018). Because the Minnesota tax was linked to the old, pre-TCJA federal standard deduction, this created the prospect that Minnesota taxpayers would need to forgo claiming Minnesota itemized deductions to use TJCA’s standard deduction for federal purposes. For some taxpayers this would have meant paying higher Minnesota taxes to qualify for lower federal taxes. However, the Minnesota Department of Revenue (MDOR) issued a taxpayer friendly revenue notice in September 2018 allowing inconsistent federal and Minnesota standard deduction elections, even though this was incompatible with the text of the law. Revenue Notice 18-01 (Sept. 4, 2018).

Parsing the language of the revenue notice (last paragraph, p. 2) very carefully would suggest that the federal standard deduction election would determine whether a taxpayer qualified to claim the nonitemizer subtraction. That incongruous result (it would have allowed some taxpayers to double deduct some of their contributions – if they used the federal standard deduction and itemized for Minnesota) was not intended, as later revealed by the instructions (p. 12).

The revenue notice eliminated the uncertainty on the issue of consistent standard deduction elections but not the complexity and confusion as to overall status of TCJA’s changes for Minnesota purposes.

Most insiders expected that the 2019 legislature would enact conformity, much of which would be retroactive to tax year 2018 both to provide tax cuts and to mitigate the ongoing complexity under multiyear provisions like cost recovery allowances. The typical taxpayer, however, would not have had a clue about any of that, of course. The 2019 legislature ultimately did precisely that but not until May 2019.

By necessity, the 2018 filing season proceeded on the assumption that Minnesota was tied to pre-TCJA federal law. Forms were constructed and filers prepared their Minnesota returns using their income and deductions under prior federal law. Despite state law linking to FTI, the combination of TCJA and the failure to pass a conformity bill compelled MDOR to construct the forms starting with AGI and providing Minnesota itemized deductions based on pre-TCJA law. See 2018 M1 instructions. Thus, a filer whose itemized deduction were higher than the pre-TCJA standard deduction but lower than the post-TCJA standard deduction would file claiming itemize deductions, including if applicable those for charitable contributions.

The 2019 legislature passed a conformity bill in May that was retroactive to tax year 2018 with regard to the treatment of TCJA’s charitable contribution changes (higher standard deduction, now directly specified by Minnesota law; higher AGI limits, etc.). This did not require most filers to amend their returns. Rather, MDOR recalculated their tax (assuming the filed forms included the necessary information) allowing the higher standard deduction and converting itemized deductions for charitable contributions to the non-itemizer deduction if applicable (i.e., greater than $500).

So, did this complexity and the potential confusion resulting from temporary nonconformity cause Minnesota filers to underreport their actual charitable contributions on their Minnesota returns (or worse to change their contributing behavior)? As a matter of logic, it should not have. There were two basic possibilities, neither of which would have resulted in less favorable treatment of charitable contributions than provided in Colorado:

  1. Legislature does nothing. MDOR’s revenue notice made it clear (as of fall 2018) that this would allow a state itemized deduction under pre-TCJA rules for state law purposes with the old lower standard deduction. This would allow full deductibility for itemizers.
  2. Legislature adopts TCJA’s charitable contribution rules. This is what happened, of course, and variations on it had been proposed in the 2018 legislative session but were not enacted. As noted above, it provides roughly similar state tax benefits to those in Colorado because of the Minnesota subtraction for nonitemizers.

Thus, either of the two likely options would have resulted in about the same tax treatment as in Colorado. No one, for example, proposed or (to my knowledge) even publicly talked about the legislature repealing or curtailing the nonitemizer deduction. In fact, lobbyists for charities had instead proposed expanding it to full deductibility.

But it is certainly possible that the confusion around what the legislature would do and a general failure to recognize that the Minnesota nonitemizer deduction remained in place (or even existed) may have affected giving more in Minnesota than the certainty that prevailed in Colorado. Confusion about how the state would respond was certainly greater in Minnesota and could have been responsible. For example, some/many taxpayers may have simply assumed, based on media coverage of the federal effects of TCJA, that their relatively modest contributions were totally nondeductible and failed to track or report them. (It’s unclear why such an effect would be different in the two states, unless the confusion about a state response in Minnesota factored in.) That could be the explanation and is my best guess but is pure speculation. (FWIW, a MDOR staffer I contacted made a similar conjecture unprompted by me.)

Could MDOR’s re-computation of itemized and standard deductions (i.e., the conversion of reported itemized deductions to nonitemizer deductions) have been responsible? That is not a credible possibility to me. I trust MDOR’s competence and if a mistake like that had been made, it surely would have come to light.

In short, Minnesota’s response to TCJA was much more muddled and confusing than Colorado’s. However, there was never any public discussion or prospect for disadvantaging charitable giving in Minnesota (whatever the response the legislature landed on) than what ultimately occurred, and which is about the same as in Colorado. Thus, it should not have affected giving decisions differentially.

Yearly variations

My last possibility was to explore year-to-year variations as well as differences in giving patterns between the two states. Giving levels vary somewhat from year to year. And it is widely recognized that giving patterns vary from state to state. For example, because of Utah’s strong Mormon ethos it typically has the highest charitable giving relative to income of any state (CNN map) and is likely less responsive to the level of tax incentives.

So, it would be useful to compare giving patterns in Colorado and Minnesota before and after TCJA. Again, what we’re trying to measure is differences in tax responsiveness, not just basic charitable giving tendencies. Unfortunately, the Colorado DOR website has only 5 years of data. It revamped its data starting in 2015 and cautions that earlier data (only 2013 is available on its website) may not be comparable.

The first graph below shows giving by residents as a percentage of AGI from 2015 to 2019 for the two states. The pre-TCJA data show some modest variability (more in Minnesota than Colorado) with the two states showing similar patterns. In two years Colorado is slightly higher and Minnesota in one. The post-TCJA data are confounding with bigger state differences and oscillations between the two years. (Possible inference is that TCJA unsettled charitable giving patterns, at least temporarily.) It’s hard to conclude anything from this, since it implies a bigger response by Minnesotans in the first year and then by Coloradans in the second year.

Decomposing the 2019 effects, giving by itemizers in both states dropped (CO dropped 6%; MN 4%). The difference was that giving by Minnesota nonitemizers increased dramatically (77%), while giving by nonitemizers in Colorado dropped slightly (4%). The large Minnesota jump obviously raises questions about its 2018 data. Both states experienced small declines in the percentage of taxpayers who itemize, although Minnesota’s was larger. The bigger drop could explain some of Minnesota’s increase in nonitemizer contributions but nothing like what occurred. I’m mystified.

Giving reported on Minnesota tax returns has been fairly stable over the last ten years, putting aside TCJA’s impact. The graph below shows 2010 to 2019 data (again as a percentage of AGI). Simple year-to-year variation seems unlikely to provide much explanatory power to understand the two state’s deviations post-TCJA.

Take away

The differences between the two states remain a mystery. A couple factors (differential changes in giving patterns and Colorado’s concentration of more of its giving in the top income strata) could explain part of the big 2018 difference. But adding a year of data further confused things with Minnesota making up all the difference and more. It suggests to me that the responses in the two states were similar and the big dip in 2018 Minnesota giving was an anomaly – either in reporting (most likely) or actual giving. It may be that the failure to enact a 2018 conformity bill with attendant publicity about that and TCJA’s effects sufficiently confused a fair number of filers so they failed to claim the nonitemizer deduction. Illogical, but possible and pure conjecture.

Addendum

Tangential points that I cannot resist making

Reading McClelland piece, spending more time reading other research on TCJA’s effects on charitable giving, and mucking around with the Colorado and Minnesota charitable contribution data reinforced in my mind the case for reforming Minnesota charitable contribution tax incentives. I am being repetitive since I have made this case before (e.g., here, here, and here) but I couldn’t resist.

There has always been a good case for reforming the Minnesota and federal charitable giving tax incentives – to increase their equity and effectiveness. TCJA strengthened that case because it:

  • Adversely affected giving. This is the obvious emerging consensus from the research. McClelland’s piece shows that it is smaller than simply looking at the federal data would suggest. But it’s still meaningful and a concern for those who believe it is appropriate to encourage charitable giving with tax incentives.
  • Dramatically concentrated tax incentives in the top income strata with its increase in the standard deduction and cap on the SALT deduction. The chart below shows the decline in Minnesota returns claiming the itemized deduction for contributions by income strata, comparing tax years 2017 (pre-TCJA) and 2019.

The change is striking. There are big drops across the aboard, but especially below $500k. Yes, Minnesota’s nonitemizer deduction continues to apply and is claimed much more heavily by the filers in strata below $250k. But they get only half the benefit of itemizers.

My favored fix.  I believe the way to do that is what I suggested in this blog post for a revenue neutral reform option:

  • Replace both deductions. The standard deduction now functions more as a zero-bracket amount (nontax threshold income amount) rather than a proxy for average itemized deductions. Given that, I see little rationale for bifurcating the level of incentive based on whether you use the standard deduction or not. The disallowance of the first $500 in the non-itemizer deduction was intended to represent (I believe) a rough measure of the portion of the standard deduction for charitable contributions. That rationale makes little sense with the much more generous standard deduction; having differing incentives is confusing without a policy rationale to justify the complexity.
  • Limit the incentive to giving over an income threshold (e.g., 2% of AGI or something similar) and a dollar minimum (e.g., $500), so more of the incentive applies at the margin. We don’t need to reward people for what most/many would give without an incentive, and this helps deter people from claiming small amounts they didn’t give because they know they won’t be audited on small amounts.
  • Use a credit so the same percentage incentive applies regardless of the tax rate and income level. Yes, high-income people may be more responsive to incentives, but appearances and equity considerations are more important.
  • Limit the credit to cash contributions, so the state does not amplify the double federal tax benefits for giving away untaxed appreciation. A big side benefit is to keep MDOR out of auditing and contesting valuations of hard to value property like real estate, art, and similar.
  • Disqualify federal itemizers from using the state credit. Given TCJA’s concentration of federal incentives, I would allocate a richer state incentive to those who lost their federal incentive. The way to do that in a revenue neutral proposal is to cut out federal itemizers. This should allow a revenue neutral credit rate of more than 15% to those who no longer qualify for the federal incentives.
  • Impose a maximum credit as a disincentive for big givers to forgo the federal deduction to qualify for a more generous Minnesota incentive. This would be a problem if the credit rate goes to 25% or more, for example. The savings from the cap will allow a higher credit rate under the revenue neutral constraint, a more powerful incentive for qualifying contributions.

My original blog post has more detail on my thinking.

Noncash contributions. One of my hobby horses is to get rid of the deduction for untaxed appreciation. Why should owners get a double tax benefit for giving appreciated assets away (no tax on the gain and its gift reduces tax on their other income), when cold hard cash is almost always more useful to charities? Other than for publicly traded securities, valuation challenges and abuses abound too.

Moreover, this benefit is concentrated at the top, raising equity concerns. The chart shows the percentages of noncash contributions by AGI class for Minnesota in 2019. About 75% of contributions by itemizers with incomes below $500k were made in cash. For those with incomes of $500k or more, about half of their contributions were.  Put another way, the noncash proportion of the top group’s contributions are twice that of the rest of the filers. You can be sure that most of those contributions include untaxed appreciation that gets the double benefit.

SOI data (with more detail for higher income filers) shows the benefits are even more concentrated at the very top.  Figure D in the SOI Report on noncash contributions for tax year 2017, shows that 39% of the noncash donations were made by returns with $10 million or more in income. Foundations and large charitable organizations are the largest beneficiaries of these donations. Id. (p, 5). This is not where Minnesota needs to or should be putting its tax incentives for donations, in my opinion. Federal largesse is sufficient.

Prospects for reform dim

The prospects for enacting a major change along these lines is slim to none. There is little legislative interest (I suggested it several times to legislators when I was working). If there were interest, lobbying would quickly snuff it out. The charity lobby generally opposes changes that take away benefits their constituent members now enjoy. They are happy to lobby for more benefits (e.g., expanding the nonitemizer deduction to 100%), but are unwilling to accept cutting back on existing benefits for a better designed incentive. At least, that was the pattern when I worked for legislature and legislators are loath to cross them.

This is just standard trade association behavior. Governing bodies and representative of trade associations have strong incentives to oppose proposals that create losers among any of their significant constituent member groups (e.g., arts or private higher educational groups that receive many large noncash gifts in this case). Policy collides with interest group politics and dynamics. This is also a big deal in trying to fix business taxation in ways that create winners and losers. Umbrella business trade associations hate mediating conflicts among their members over proposals (no matter how meritorious); it’s easier to just oppose them.

Categories
income tax

Donations w/o deductions

Two recent gifts of appreciated property by billionaires to 501(c)(4) social welfare organizations have attracted national media coverage. A primary purpose of both gifts clearly is political (lobbying, affecting campaigns, and similar to promote the donors’ policy agendas) based on the news stories. The gifts illustrate problems with the tax treatment of donations for political advocacy relative to charitable contributions.

501(c)(4)s can be a wide variety of groups, but most attention focuses on advocacy groups like the NRA and Sierra Club (Citizens United also was a 501(c)(4)).  Contributions to them do not qualify for the income tax and estate taxes charitable contribution deductions, which only apply to contributions to 501(c)(3) organizations and governmental entities. Thus, the explicit tax incentives for charitable donations do not apply. But (c)(4)s are exempt from income tax and gifts to them are exempt from gift tax.

They also are subject to fewer restrictions on their political activities than (c)(3)s, which are  “absolutely prohibited” in the IRS’s words from participating in political campaigns and are subject to stringent limits on lobbying. By contrast, (c)(4)s can engage in lobbying and political campaign activities, subject to limits (e.g., political campaigns cannot be their “primary” activity). See the IRS’s description of the limits.

Thus, ordinary contributions for political advocacy and campaigns do not qualify for tax benefits/subsidies (i.e., the itemized deduction for charitable contributions). But through a confluence of factors these billionaires’ gifts qualify for similar tax benefits. It’s unclear whether Congress intended that result, but it is hard for me to see a policy justification for it.

The donations

The two donations were made by the founder of Patagonia (the Chouinard family), an outdoor equipment and clothing company, and by an owner and chairman (Barre Seid) of Tripp Lite, an electronics manufacturer (less of a household name without the ubiquitous clothing labels). The purpose of the former donation was to further environmental efforts (e.g., to limit climate change) and the latter to further conservative capture of the federal and state judiciaries:

The editorial reaction predictably depended on the ideological priors of the commentators. See e.g.:

  • National Review (unhappy with the Patagonia contribution, characterizing it as hypocritical for a socialist to not give the money to the government)
  • Ruth Marcus (unhappy with the Tripp Lite donation, mainly on the basis of too much opaque money in politics)

Based on the media coverage, the donations are similar with some differences. The Patagonia owners retained ownership and control of their voting shares and, thus, control of the company. They did this by transferring and paying gift tax on those shares, a small dollar amount in the company’s overall capital structure (other public companies, Ford and Facebook to pick two, have similar structures). By contrast, the Tripp Lite shares were donated before the business was sold to an Irish entity (another potential tax dodge?). As exempt entities neither will likely owe tax on its income.

Why they work

Even though they do not qualify for the explicit tax incentives for charitable giving, the income and estate tax deductions, these donations provide similar tax benefits to most cash contributions that qualify for the itemized deduction or as a qualified charitable distribution from an IRA.

Income tax

This works under the income tax because the realization requirement does not treat appreciation as income until an asset is sold or exchanged. That longstanding practice is partially for administrative reasons (it avoids nasty valuation issues) and partially for political and practical reasons (mainly liquidity issues for donors). Gifts typically have not been treated as realization events. Instead, the recipient takes the owner’s basis (carryover basis) and is obliged to pay any tax when she sells. A recipient exempt entity is not taxable. So giving an appreciated asset to one, such as a (c)(4), causes the potential income tax on the appreciation to evaporate. The donor gives the income tax on appreciation away without incurring tax. (Note: you can’t do this with ordinary income, like wages, because of the assignment of income rule. Yet, another preference for owners of appreciated capital assets.) Importantly, as noted below, IRS regulations treat gifts to political organizations as taxable realizations, requiring the donor to pay tax as if the asset were sold. When Congress exempted gifts to (c)(4) from the gift tax, it did not apply a similar rule. It is unclear if that was intentional.

But contributors of most appreciated property to charities get a double benefit. They don’t pay tax on the embedded capital gain and the fair market value deduction reduces the tax on other income. It is like allowing a worker to direct some of her wages to be paid to a charity and both excluding those wages from her income and allowing her to deduct them, reducing tax on her other wages. The Chouinards and Seid passed up that double benefit. Their tax bases in the contributed shares was undoubtedly very low (probably close to zero), and that capital gain tax, thus, substantial. So, they gave up a big tax benefit to satisfy their political advocacy ends.

Without knowing much about either, that decision is likely explained by two factors:

  • Most simplistically, the donors valued funding political advocacy more than any activity that qualifies for the charitable tax deduction. On the surface, they would seem to value advocacy by a lot more, since a charitable deduction yields up to 37% of the value of the contributed property (subject to AGI percentage limits). But the value of the tax incentive partially depends upon how much of a bite the income tax imposes on them, the second factor. If they have other ways to avoid the income tax, the implicit value of the charitable deduction drops.
  • The income tax for the typical billionaire is probably not that big a deal. Relative to their incomes, many pay very little; some billionaires also pay little in absolute terms. Many of us tax geeks assumed that was so and the ProPublica stories confirmed it. Current income tax rates are relatively low, especially those applicable to capital gain and dividend income, and billionaires can use Professor Ed McCaffery’s strategy of Buy, Borrow, and Die, along with a variety of other techniques to reduce their tax burden. Because the income tax on them can be avoided in other ways, charitable giving incentives have less value to billionaires.

Size of the tax benefits. To provide some context, the two tables below illustrate the tax benefits for contributions of zero basis property made by top tax bracket taxpayers in Minnesota to a (c)(4) entity (political purpose) versus to a (c)(3) entity (charitable purpose). The Chouinards’ donation will yield more tax benefits than the table shows, because (I assume) they are California taxpayers. California’s top tax rate is higher than Minnesota’s (13.3% versus 9.85%). Seid appears to live in Illinois, which has a flat 4.95% state tax rate. The table shows the donors gave up potential income tax benefits of more than 40% of their donations to promote their political agendas, rather than accomplishing similar ends through activities conducted by (c)(3) entities.

Since a theme of this post is to contrast the treatment of donations by the very affluent and middle income charitable contributors, the second table shows the income tax benefits for cash contributions – for itemizers in the top bracket and 24% federal bracket (typical for upper and middle income filers) and for nonitemizers (almost 90% of filers after TCJA). The two tables show that the Chouinards and Seid received tax benefits for their donations equal to or greater than those received by the vast majority of the population who make cash charitable contributions. Only households with taxable incomes that put them in the 32% federal bracket ($340K+ of taxable income for a married joint filer) who itemize deductions do better.

Tax benefits for contribution of zero basis property
 PoliticalCharitable
Federal  
 Avoid cap gain tax23.8%23.8%
 FMV deduction037%
Minnesota  
 Avoid cap gain tax9.85%9.85%
 FMV deduction09.85%
TOTAL33.65%80.5%
Tax benefits for cash charitable contributions
Itemizer top bracket
 Federal37%
 Minnesota9.85%
Total46.85%
Itemizer 24% bracket 
 Federal24%
 Minnesota7.85%
Total31.85%
Nonitemizer 
 Federal0
 Minnesota3.93%
Total3.93%

Estate tax

The estate tax does not apply because the donor no longer owns the property when he or she dies. Seid is reportedly childless, reducing his incentive (I assume) to leave money to heirs. From an estate tax perspective, the gifting strategy provides equivalent tax benefits to bequests to charities.

Early deaths may reverse the benefits. There is one potential fly in the oinment – something I haven’t seen mentioned in the press, so I might be wrong about it. If the donor dies within three years of making the gift, the estate tax pulls the donation back into the estate. I.R.C. § 2035. (The provision also pulls any gift tax paid back into the estate (none here, of course), to make up for the difference between the tax inclusive and tax exclusive ways the two taxes are computed. Otherwise, one could save tax by making deathbed gifts of all one’s property subject to estate taxation.) If I am correct about application of this provision, I’m sure the donations contain legal limits that would transfer money or property back to the estate to provide the wherewithal to pay the tax or other mechanisms are used to address it.

Gift tax

This works under the gift tax because gifts to (c)(4)s are exempt from the gift tax (I.R.C. § 2501(a)(6)). Congress exempted those gifts from gift taxation in 2015. JCT Blue Book, JCS1-16 (March 14, 2016) pp. 333-35. Before that change, these gifts were likely taxable gifts. See this 2012 CRS publication, John R. Luckey and Erica K. Lunder, 501(c)(4)s and the Gift Tax: Legal Analysis (August 10, 2012), for background information on the legal issues. The IRS in 2011 started to enforce the tax but backed off in the face of political opposition. Congress enacted the exemption to prevent IRS from changing its mind, I assume.

Gifts to political organizations (political parties and similar entities under I.R.C. § 527(e)(1)) were already exempt (I.R.C. § 2501(a)(4)) and it was generally thought that the 2015 Congressional change put these gifts on equal footing. But and it is a big but, donations of appreciated property to a political campaigns or other section 527 entities are taxable realizations by the donors triggering capital gain tax. Treas. Reg § 1,84-1. Congress did not apply it to donations to (c)(4)s. Of course, many (c)(4)s do not mainly engaged in political advocacy, so that may have been a factor in Congress’s decision. In any case, gifts to 527s and to (c)(4)s are treated very differently. Here is how Arnold & Porter described it in a client newsletter after 2015 enactment of the exemption:

A donation of appreciated stock to a political organization is a taxable transaction. For transfers of stock to political organizations, the Code treats the donor as having sold the stock to the political organization. The donor pays tax on the difference between the fair market value of the stock at the time of the transfer and the donor’s adjusted basis in the stock. The donor will pay tax at capital gains rates for stock held for more than one year or at ordinary income rates for stock held for one year or less. However, the transfer is not subject to gift tax.

Arnold & Porter Private Client Newsletter, Donations of Appreciated Stock to Social Welfare and Political Organizations (March 25, 2016).

The newsletter highlighted the tax advantages created by the 2015 Congressional change in the gift tax. (It points out that the (c)(4) needs to wait a year after realizing the income before making the political expenditure to avoid paying corporate tax on the income, so timing issues must be paid attention to.) The Patagonia and Tripp Lite gifts are exactly what one should expect from the 2015 change. I assume knowledgeable Congressional staffers (e.g., at Joint Committee or in the House and Senate drafting offices) informed the staffs of the relevant members or of the tax writing committees. Whether the members consciously chose not to apply the realization rule is unclear. I suspect that they did and were okay with it (there were Republican majorities in both houses who were generally favorably inclined toward the rule in Citizens United) but that is just idle speculation.

What’s wrong with this picture?

These donations reveal policy problems with the income tax and its incentives for charitable giving. Nothing new.

  • Political limits on charitable tax incentives effectively don’t apply to rich business owners. The law prohibits claiming the itemized deduction for contributions to entities that lobby too much or engage in campaign activity. Seid and the Chouinards got an equally valuable benefit from their donations. This is so because the typical charitable giver (i.e., of cash) avoids paying income tax on the income they give away (at most, assuming other itemized deductions equal the standard deduction or a QCD is made). Seid and the Chouinards, by contrast, got the same benefit (no tax on the appreciation in their shares which probably have close to a zero basis) for contributions for political advocacy. Whatever one thinks about the limit on lobbying and political activity, that seems fundamentally unfair to have one set of rules de facto for wealthy business owners and another for the rest of the population. Even if one accepts that capitalism allows the successful to speak with a much louder voice than the average Joe or Jane, that does not justify the government further amplifying their voices via special tax rules.
  • Uber generous tax incentives for charitable gifts of appreciated property aren’t enough to overcome the preference for political advocacy. Charitable contribution rules are exceeding generous for large donations of the appreciated property with very low bases. That generosity is not enough to induce big givers like the Chouinards or Seid to focus on charitable ways to achieve their political ends (e.g., through education, direct environmental efforts rather than political advocacy, and similar).
  • Should we subsidize political advocacy and speech? An underlying philosophical question is whether the government should subsidize political speech. The current system is flawed because it does that only for holders of highly appreciated (or tax depreciated but still valuable) assets, mainly benefiting the rich. But some might argue that the speech restrictions on charities should be relaxed, providing more egalitarian incentives for political speech. I don’t think so. High levels and steady growth in campaign expenditures (data available at websites like OpenSecrets.org) belie the need to subsidize more political speech. I certainly don’t think we need to subsidize the speech/contributions Tim Miller describes in this NYT op-ed to treat the little guy the same as big spenders.
  • Realization rule results in under taxation. These events are one more manifestation of how the realization rule, in its current form, creates holes in the tax base for wealthy business owners. (Stepped up basis on death is a bigger issue.) A rule justified by administrative convenience and liquidity concerns should not drive such a large hole in the tax for the uber rich. It’s an easy step to treat gifts to (c)(4) entities as realizations. Liquidity and valuation issues just don’t cut it in this context.
  • The uneven application of charitable giving tax incentives invites cynicism. To the extent public is paying attention, these events encourage populist opposition to the income tax and undercut support for charitble giving incentives. It certainly looks like one set of rules applies to the wealthy and another to everyone else.

Potential fixes

Steve Rosenthal at Forbes suggests two obvious fixes:

  • Yank the gift tax exemption for donations to (c)(4)s. That would essentially reverse the 2015 change or impose limits when conditions are present (e.g., political activity of the entity).
  • Treat the gift as a realization (i.e., making the donors pay tax as is done for contributions to 527(e)(1) orgs).

The gift tax solution is more direct and would impose a higher rate (40% gift tax rate versus the applicable long term capital gains rate, typically 23.8% for high income filers). Without a lot of careful thought, I prefer the second approach:

  • It provides symmetry with the treatment of gifts to political entities, since that is the rule for contributions to 527 organizations.
  • It has a wider reach. The gift and estate tax exemption amount is $12 million ($24 million for a married couple). The taxes apply to only a small percentage of the population. Using the gift tax mechanism will enable the near rich with appreciated assets to still use the technique. Few will but why allow it for those so inclined?
  • I have a residual concern that the current version of SCOTUS may consider the gift tax approach to violate the First Amendment. It looks like a direct tax on political speech (assuming 501(c)(4) gifts = political spending = speech). It appears to be content based and targeted at a type of speech especially protected by the First Amendment, political speech. A Court whose composition is even more likely to be inclined toward Citizens United style thinking could easily get there. The income tax treatment looks more neutral to me. See this CRS publication for a contrary analysis that concludes gift taxation would likely survive a First Amendment challenge because it would not be considered content based. As an aside, I do wonder if the current Court would reach the same result as Cammarano v. U.S. 358 U.S. 498 (1959) (upholding disallowance of lobbying as business expense deduction). I have always considered its holding a bit off; if the spending qualifies as an ordinary and necessary business expense, taxing it does not deny a subsidy but rather imposes a penalty. That assumes the norm is a net business income tax, making a special tax rule disfavoring a constitutionally protected form of business activity (disallowing business expenses for political advocacy) questionable. The economic and tax sophistication of the 1950s era SCOTUS left something to be desired.
  • It would reenforce my policy priors regarding the income tax (i.e., consumed income should be taxed and giving money for political advocacy is consumption).
  • It has slightly more SALT benefits. Adding it to the income tax base will potentially benefit state income tax bases. By comparison, few states have estate taxes and only Connecticut has a true gift tax. Imposing the federal gift tax, of course, is likely to deter a fair number of contributions and, thus, indirectly augment state income tax bases.

Is Congress likely to do anything about this? Of course not. It’s Congress after all. They take action on stuff like this only if there’s a bipartisan consensus to do so or if one side is in control and considers it to give them some political advantage (satisfy their base, pay for something, etc.). Neither applies here as far as I can tell. Of course, if you want to know what Congress is going to do, you’re better off flipping a coin than asking me. Something should be done, as well as a more general fix for the charitable contribution incentives, which seems even less likely.

Categories
income tax

Senate retirement legislation

The Senate released (9/8/22) the legislative language for its version of the retirement changes passed by the House, Section-by-section summary; text of bill; JCT revenue estimate. This language is the product of the June markup session. I assume it will appear on the Senate calendar at some point soon.

I have blogged about this here. As smarter and more knowledgeable people than me (Professors Hemel and Doran) have pointed out, these types of changes largely benefit the affluent and financial services industry, not the average income people that Senator Wyden refers to in his press release: “we are making significant progress for millions of low- and middle-income workers, who are far less likely to have adequate retirement savings. These workers frequently have physical, demanding jobs, and often depend solely on their Social Security income.”

That is supposed to happen by providing incentives for employers and employees to participate in the plans. The track record for actually increasing participation by folks with ordinary incomes is lackluster at best. The Senate version includes matching contributions, which I have not seen done before (other than by states for their 529 plans). That will present some administrative challenges. Will be interested to see if that survives and how it is done mechanically, although my hope is the legislation fails to pass altogether.

As fiscal payfors, both bills rely on moving more retirement plans to the Roth structure – allowing Simple IRAs and SEP IRAs to be done as Roths and moving catchup contributions to the Roth structure. That makes their overall effects revenue neutral within the 10-year budget window. Moving from the traditional defined contribution or DC structure to Roths just delays the revenue loss from those accounts or accelerates the revenue collection, a gimmick to get around budget rules, shifting the cost to later generations, etc.

I think we should be moving in the opposite direction on a policy basis. The Roth structure is more regressive than traditional IRAs and 401ks because accounts with higher investment returns, all else equal, pay lower tax rates on a lifetime basis. Investment returns are likely strongly correlated with having higher incomes and account values, hence the regressivity. Some enterprising economist should study this to quantify the effect. But measuring life time incidence is empiricially challenging and is rarely done as a result.

The Senate bill does contain a modest fix to the problem of syndicated conservation easements as one of its payfors. The change limits the charitable deduction to 2½ times the investor’s tax basis. But that limit only applies for 3 years. After that the sky’s the limit once again. This is what passes for reform in Congress. What’s wrong with limiting the deduction to one’s tax basis in the land permanently? That’s a more principled approach (my take from 2 years ago).

Aside: I do recognize that the 2.5X limit is an improvement over the status quo. Promoters of syndicated conservation easements market them as providing tax savings equal to or greater than the investment. That requires phony valuation multiples based on the investor’s marginal tax rate (i.e., 1/t where t is the investor’s marginal tax rate). So, an investor in the top 37% bracket would require a multiple of 2.7X, just above the 2.5 threshold. Despite the IRS making these deals listed transactions, they are still being done! Note that this would have no effect on how Trump, as alleged by the NY attorney general (Politico story), abused conservation easements. His abuse is the old fashioned-approach of existing land owners wildly overvaluing the easements. More comprehensive reform is needed.

Given the bipartisan support in both the House and Senate, the chances of passage of some changes is high. The Senate bill differs from the House bill in material ways (e.g., it delays the major RMD changes until outside of the budget window and the House implements them more quickly). So, those differences will need to be resolved and time is running out. The Senate (typically slow in processing legislation) still must pass this. So, there may be hope the effort dies. But bipartisan changes like this often pass in lame duck sessions. Members mistakenly think of this stuff as reform, many want to look bipartisan, interest groups are strongly behind it (that should be a warning in and of itself), etc. I see this passing in late November or December as part of package of extenders and/or a FY2023 budget deal (Congress seems likely to kick that down the road until after the midterms).

As I noted in a previous post, the RMD changes result in an automatic hit to state revenues – no state action necessary to conform because Minnesota has no RMD rules, Federal rules are enforced with an excise tax, essentially a penalty (i.e., no state conformity or revenues). So, the Senate’s delay until next decade would put off that revenue loss. That also would eliminate the asymmetry problem with revenue offsets for the RMD changes in the House version. The RMD changes reduce federal revenues. The federal bill offsets the lost revenues from the RMD change with revenue raisers. A state conformity bill will score conforming to those provisions to extent they increase FTI, as most do, as raising state revenues (while ignoring the RMD revenue loss that occur automatically), which the legislature offsets by including tax cuts in a conformity bill. Otherwise, the bill would be a tax increase. The overall effect of the automatic reduction from federal passage of RMD changes and a conformity bill typically results in a net state tax cut. The effect, of course, is very small.

Bottom line. Some version of this is likely to pass. The principal effects will be more assets in Roth plans, affluent account holders keeping assets in retirement accounts longer to pass on to their heirs, larger budget deficits, and little help for middle and lower income households who are failing to save adequately for retirement. In short, little good and the opposite of what Senator Wyden’s press release claims. But it will pass on a bipartisan basis and members of Congress will congratulate themselves for enacting bipartisan “reform.” Minnesota will suffer a small reduction in its tax revenues because of the RMD changes.

Categories
estate tax income tax

Charitable contribution incentive reform

Gene Steuerle has a TPC post, How to Undertake Reform of the Charitable Deduction, on how to improve charitable giving tax incentives. As he says, TCJA’s changes focused charitable giving incentives on those with “well above average” incomes. Most ordinary folks now use the standard deduction. Gene thinks that will be politically intolerable and so the incentives should be modified.

My observation: the public now seems perfectly willing to tolerate tax provisions that lopsidedly favor those with high incomes. The underwhelming to nonexistent response to ProPublica’s disclosures are the latest evidence. I don’t doubt that the public would be outraged if it focused on this stuff. But most don’t. Even those plugged into politics tend not to, unless Fox News or MSNBC pounds it into their skulls. Even then, Congress typically does nothing unless both tribes’ mouthpieces agree it’s outrageous or when one party has total control and considers changing it to be in its interest (that’s how we got the SALT deduction cap).

Steuerle’s advice

As usual, Steuerle has sensible and insightful things to say. He focuses on how to evaluate proposals, not promoting specific solutions. I think you can distill his advice down to two main points:

  1. Evaluate cost-effectiveness (i.e., how much will a proposed change increase giving relative to its cost). Many of proposals, including the nonitemizer deduction in place in 2020 and 2021, score poorly under this metric (e.g., generating $1 of contributions for each $5 of tax reductions).
  2. Focus on the charitable beneficiaries (i.e., do the objects of the charity benefit), not the taxpayer/donors or charities themselves.

He spends most of his time on the first point, but the second is also important. Too many contributions take too long to get to actual targets (looking at you, donor advised funds) or never do (looking at you, private foundations and charities with high fund-raising expenses).

My observation is that to truly improve or reform the deduction, Congress should curtail existing benefits. (Steuerle says nothing on that score.) Nobody seems to be willing to take away existing benefits that score poorly or are simply unjustifiable. Deductibility of the fair market value of the appreciated property is the poster child for reform. Fixing something as grievous as the thievery going on with syndicated conservation easements is tying Congress in knots (Bloomberg; thank you Senator Sinema). There is little hope for real reform, just layering on more benefits or incentives.

SALT and charity contrasted

Whenever I think about TCJA and charitable contribution incentives my mind wanders to making comparisons with the SALT deduction. For decades, I thought that both deductions needed major reforms. (My thoughts on how to fix the SALT deduction are at the end of this post.) Both serve similar purposes, providing a tax offset for one’s income that goes for public goods or income transfers. Yes, the charity deductions have a stronger voluntary element and, thus, has an incentive component. But some supporters of TJCA’s SALT deduction cap justify it as an incentive to reign in too high state and local taxing and spending. Also, an omniscient analysis would likely find material elements of personal consumption and/or image buffing in charitable contributions, rather than Sermon on the Mount style benevolence, the Sackler family donations being a classic case. A couple random observations about the pre-TCJA SALT deduction and the charitable contribution follow.

Both are regressive

Dems’ proposals in Congress to restore the SALT deduction have been accurately pilloried (left, right, and center) as regressive and, thus, hypocritical for tax-the-rich liberals to support. The charitable contribution deduction (especially post-TCJA) has a similar regressive distribution, if you focus on the donors. (I don’t know which is more regressive and to be fair the uses of the funds, whether taxes or contributions, need to be accounted for. As Gene points out, the ultimate beneficiaries are the key. My instincts are that SALT payments provide more public goods and income transfers to poorer folks than charitable contributions do. Just my intuition. More below.) But no one is criticizing it on that basis or proposing to curtail it for high income contributors. That reveals the power of the status quo and how TCJA’s changes dictate the terms of the debate. As I suggested in my SALT post, it’s hard not to conclude that the 2017 GOP landed on restricting the SALT deduction mainly to target high tax blue states. Proponents of charitable incentives are using TCJA’s restrictions to provide even more tax expenditures, not to restrict or level the playing field for the two deductions.

Charitable contribution deduction has more ugly features than the old SALT deduction

Consider if the SALT deduction allowed full deductibility of:

  • The fair market value of taxes paid by conveying appreciated properties to a governmental unit without taxing the benefit of the appreciation (charitable deduction does that)
  • Taxes paid to entities that you created and that employ your family members (deduction allowed for contributions to private foundations)
  • Paying taxes for multiple years in one installment because your income is high, providing a self-help income averaging and allowing you to control investment of the funds (contributions to donor advised funds allow that)
  • Taxes paid for purposes you select from a broad list of very generally stated functions perhaps yielding few public goods or help for poor folks (see Bloomberg, Bored in Retirement? Start a 501(c) Charity for Fun and Profit; SALT deduction at least has a democratically chosen governmental entity that imposes a check on how the money is deployed, even if that may be self-serving if you’re de facto purchasing high quality education for your offspring by choosing where to live)
  • Taxes paid to support construction of facilities you require to be named after you or your family

There is a good case for charitable giving tax incentives. The current incentives are just poorly designed, overly generous for some and nonexistent for others. Why favor old people with IRAs? Why turbocharge incentives for giving appreciated property? Why favor the hypocrite who trumpets his gifts over the widow’s mite? These incentives look more like historical accidents than well-considered policies.

True fix requires better targeting of current tax expenditures

Rather than layering more benefits on top of existing benefits, which is what Congress will do if it does anything, existing benefits should be redesigned and better targeted to stimulate giving more cost effectively and to treat all givers more equally. The ability to game play should be limited. To me that suggests federal reform along the lines of my proposal for Minnesota, which I think is consistent with Gene’s recommendations:

  • Repeal the itemized deduction and ability to make nontaxable IRAs transfers. Impose some reasonable limits on the estate tax deduction – e.g., limiting it to no more than 50% of the gross estate
  • Allow a tax credit to all givers at the same rate, eliminating the tilting of benefits to higher-income taxpayers; set this rate to be revenue neutral with the current incentives that are repealed or limited.
  • Limit the credit to cash contributions and (second best) to one’s tax basis in contributed property – this eliminates most valuation problems (and game playing like conservation easements), as well as the uneven effects and unjustifiable benefits of the fair market value deduction of appreciated property.
  • Limit the credit to contributions above a minimum threshold of contributions, based on a small percentage of AGI, to better focus incentives on marginal giving.

All wishful thinking of course. The charitable industrial complex will make serious consideration of any of these elements verboten.

Postscript

Steuerle’s post and my posts largely focus on the deduction as an incentive for giving. The deduction has been justified on the philosophical basis that charitable contributions are no longer part of the taxpayer’s ability to pay under Haig-Simon’s style income concepts. (Note it is hard to extend that logic to untaxed appreciation on contributed property, which the realization requirement has already removed from income. Deducting excludes it yet again.) The cap on the SALT deduction, particularly to the extent it applies to progressive state income taxes, makes it harder for me to take that contention seriously. Charitable contributions surely have larger components of implicit consumption than paying a progressive state income tax. Thanks to TCJA, the latter is taxed and the former deductible (subject to limits, obviously).

Categories
income tax

Dumb tax policies, Sinema edition

Biden’s Build Back Better (BBB) proposal is on life support, its fate in the hands of two centrist Democrats, Senators Joe Manchin and Krysten Sinema. With a 50-50 Senate split and the partisan polarization in Congress (i.e., obtaining GOP support is practically impossible), each Democratic senator has a theoretical say as to what provisions are in the bill or if it will pass at all. Commonsense seems likely to prevail and the Dems will conclude that half a loaf is better than none at all, especially since they are all but certain to lose control of one or both houses in the 2022 midterms. Thus, holding out for a full loaf likely means no bread until 2025 at the earliest. So, I’m still expecting a version of BBB to pass and to contain tax provisions as payfors. That means somehow meeting or finessing Manchin’s and Sinema’s tax demands.

Manchin’s reservations appear mainly to focus on the size of bill, how it is financed, spending provisions, and the child tax credit’s details. All those are important issues (some of which I have views on), but my focus is on taxes. The child credit is part of the tax system, but it’s mainly a spending program of sorts (income or wage supplement) in my view – at least the expanded generosity and refundability that are at issue and, in case, major changes appear dead. Manchin’s general tax views seem conventional. Bloomberg, for example, recently quoted him as saying “just fix the tax code” is what he wants in BBB. Thus, Sinema’s tax views may be more important – at least for the tax policy issues that I care about.

[Sidebar: I may be totally wrong. Politico (Burgess Everett, Dems face a sobering possibility: Build Back … never, 2/10/2022): “Manchin advised his party to start with rolling back the tax cuts that former President Donald Trump signed four years ago: ‘Get you a good piece of tax legislation. It’s the only thing Democrats agree on.'” A similar case is made in this WaPo story, which suggests BBB could be reformulated as a partial deficit reduction effort. I’ll be surprised if that happens. Dems may agree on the need tax increases on corporations and high income individuals. But enacting tax increase/deficit reduction legislation in a runup to the midterms seems unlikely. That may appeal to Manchin, but assembling GOP-free majorities in both houses to impose a tax increase only part of which funds new program expansions would be a very tall order. Republicans used to refer to deficit reduction legislation as root canal conservativism and moved on to deficit-friendly, tax cuts forever and always. I suspect enough Dems harbor similar feelings about tax increases to fund both programs and deficit reduction to nix the effort.]

If I’m correct, the tax changes getting Sinema’s vote will compel are important, viz they will become law. It appears that her opposition has taken three provisions off the table (all unfortunate from my perspective):

  • Increasing the corporate tax rate (Manchin has said he is willing to go to 25%)
  • Limiting or repealing QBI, the deduction for pass through entities (PTEs)
  • Limiting the charitable deduction for conservation easements

Sinema’s background

Sinema had not been on my radar, so I embarked on reading a bit about her and discovered some seemingly weird views on the TCJA and tax policy. She is an interesting political story with her views migrating from extreme left (initially unsuccessfully running as a Green Party candidate for the Arizona legislature and, then, winning as a liberal Dem) to somewhere in the middle (centrist Dem). This Politico profile (October 2021) chronicles her metamorphosis and politics generally. It implies she is running against her party to ensure her reelection in conservative but increasingly purple Arizona.  She comes across as an astute student of The Prince style politics, 21st century style electoral version. It is probably safe to conclude that her policy positions are heavily driven by how they will play out on the basic retail political level in her election campaigns. At least that is my best guess. The Politico profile is worth reading for political junkies. It provides some insights into how state legislative politics work (she was a caucus leader in the Arizona Senate). In that regard, Arizona seems little different than what I observed in Minnesota.

TCJA no vote a mixed signal

The corporate tax rate and QBI are both TCJA provisions. Both Manchin and Sinema voted against TCJA, so one might presume that they would be okay with unwinding or softening its provisions. But, of course, one can vote against a bill because one or two provisions are bad enough to justify a no vote, even though you like much of the bill or think it is politically compelling (especially if you represent a red state as Manchin does and as Sinema probably thinks she does or thinks it is politically savvy to act like she does, since her reelection risk is mainly from the right, not the left). That appears to be the case here with an unexpected turn.

Corporate rate cuts

The corporate rate cuts were the centerpiece of the TCJA. The cut was much deeper than most thought would or needed to occur. Before TCJA, a consensus was that a 25-percent rate would be good compared to the then 35-percent rate. Trump pushed for 20% or lower (need to discount for his reflexive impulse to exaggerate) and the final deal was 21%. A natural assumption was that ratcheting that up a bit to 25% (Biden proposed 28%) would not give any Democrat heartburn. Wrong!  Apparently, any corporate rate increase was unacceptable to Sinema. (Manchin is okay raising it to 25%.)

That forced going to Plan B, a corporate alternative minimum tax or AMT on book income. That is a step back if the reason for the opposition to a rate increase is that it will discourage investment, the prime reason for the original rate cut. The proposed AMT will hit firms that invest heavily in equipment (have large depreciation deductions) hard, while a rate increase hits those with a lot of income after depreciation and other expenses harder. The rate increase while allowing expensing (bonus depreciation unreduced by an AMT) is consistent with the current fashion as to how best structure a corporate tax. See Shaviro, Bittker’s Pendulum and Taxation of Multinationals Tax Notes III.C.2 (11/1/21). Which is better to encourage investment?  See this TPC blog post for a more detailed explanation.

A book income AMT will have other bad effects: complexity, harder to administer and comply with, more opaqueness, may encourage distorting financial accounting, etc. Minimum taxes generally do not make sense. But sometimes they’re the best we can politically muster. Dan Shaviro in an abstract for his article on minimum taxes (like GILTI) succinctly makes the point:

Minimum taxes * * * have serious drawbacks, and generally make sense, if at all, only if otherwise superior options must be ruled out for reasons of optics or political economy. Yet, given the “compared to what?” question that haunts all real-world tax policy-making, one cannot reasonably say that they should never be used. Still, any such use should generally be contingent, reluctant, and based on understanding their structural deficiencies.

What Are Minimum Taxes and Why Might One Favor or Disfavor Them?

I can understand why Sinema opposes raising the rate. Rates are highly visible and easy to explain/message. Groups of businesses, some of them vocal, will be hurt by the rate increase but will not pay an AMT (many retail businesses, obviously). Insisting on an AMT rather than just increasing the rate a bit is suboptimal (translation: dumb). But I can easily see how you get there. It does not strike me as more centrist or moderate, just more opaque and dodgy.

Side benefit of Congress enacting the corporate AMT: It gives Minnesota an out to ditch its linkage to the pre-TCJA federal corporate AMT. That is untenable administratively and practically for much longer. I suspect that DFLers, including Governor Walz (given his public rhetoric about big corporations not needing anything), will be reluctant to simply repeal Minnesota corporate AMT because of the revenue loss. If Congress enacts a new federal AMT, Minnesota could conform and avoid the revenue loss from repealing its AMT or the pain of raising the lost revenue in some other way.

Qualified business income (QBI)

I have made clear my distain for QBI (TCJA folly: QBI), the 20-percent deduction for pass through tax entities (PTEs) enacted in TCJA. In my view, this is simply one of TCJA’s worst provisions – not only does it lack any policy justification, but it also has a high revenue cost, violates horizontal and vertical equity principles, and is inefficient, while being immensely complicated to understand and apply. (Disclosure: I personally benefit from the provision by virtue of some of my investments.) Although Biden’s tax pledge (see my rant Tax pledges are dumb) ruled out cutting it back in his budget, I hoped the congressional Democrats might do so. Well, the House did not, and it appears Sinema stands in the way of the Senate doing something, my last hope.

In 2017, then a House member, Sinema voted against TCJA. According to a local Arizona television station, she released this statement explaining her opposition (the full statement does not appear to be available on her congressional website any longer):

This bill is a bad deal for Arizona. It explodes the federal debt, likely raises taxes on many small businesses, and makes it harder for Arizona families to get ahead.

I oppose this bill because it does not reflect the values and priorities of hardworking Arizonans. I would like to support bipartisan tax reform that upholds our values, but tax cuts are not tax reform. Passing unbalanced tax cuts for short-term political gain is not in the best interest of Arizona or the American people.

Brahm Resnik, Why Sinema Said “no,” and then “yes” on Trump Tax Cut

That sounds like typical Democratic opposition, cloaked in fiscal conservatism raising concerns about the deficit. In 2018 when House Republicans brought up a proposal to make many of TCJA’s individual income tax cuts permanent, Sinema flipped and voted for the bill. This is how she explained her rationale:

My big complaint when the tax bill passed last November was that it didn’t provide permanency for small businesses who use pass-through taxes to run their businesses and it didn’t provide permanency for middle-class families, so I voted no.

The bill that Congress passed recently extended those two provisions, my chief concerns, which is why I voted yes.

Why Sinema Said “no,” and then “yes” on Trump Tax Cut (emphasis added).

There’s some obvious fiscal illogic in those two votes and her rationale for them, since the second one would have created a bigger deficit hit, her original, stated reason for her no vote. But the bad news is that her apparent objection is that QBI, along with the other individual provisions, was not permanent. So, she thinks QBI was a good thing. She actually calls out her support for it!

This doesn’t say much about Sinema’s tax policy chops or just reveals her political sense. The Politico story linked above quotes a former Arizona legislative colleague as characterizing her as typically the smartest person in the room. So, what gives? Well, politics, labelling, and perception. To wit: it was genius by QBI’s sponsors to describe it as a small business provision, since support for small business is like being in favor of apple pie. This political reality is what Sinema probably perceives and conveniently latches on as a justification for her weird/having it both ways TCJA voting. The reality, as revealed by data on PTEs and the ProPublica stories I linked to in my QBI post, is different. Many businesses that benefit from QBI are large by anyone’s lights and very affluent owners and investors are its biggest beneficiaries. But “Look for the Small Business Label” and political support will follow.

Bottom line: QBI is a lethal combination of bad policy and good politics.

When I worked in the legislature, I had a similarly revealing experience about the power of the small business label. We often had to come up with proposed revenue raisers for Democratic members who wanted to make up revenue shortfalls or to pay for proposed spending. They knew these policies would not be enacted because of Republican opposition and control of either the House, Senate, or both, but they needed or wanted to make proposals fiscally balance in politically acceptable ways (to their base and swing voters). Several times I suggested repealing Minnesota’s conformity to the I.R.C. § 1202’s exclusion for capital gain on “qualified small business stock.” I reasoned that that would be consistent with their principle of taxing high income individuals and was poor policy for multiple reasons (violating both horizontal and vertical equity and unlikely to be effective in encouraging investment). However, it never made the cut because members were concerned that it would be characterized as a tax on small business, a testament to the power of labels. Small business was right in the its formal name, after all. In one instance, the legislator instead opted for a surcharge on already taxable capital gains, which in my judgment was bad policy from a horizontal equity perspective (Minnesota already taxes those gains like ordinary income). After I retired more evidence has come out revealing that the qualified small business stock exclusion and exemption is worse than I imagined. See Manoj Viswanathan, The Qualified Small Business Stock Exclusion: How Startup Shareholders Get $10 Million (Or More) Tax-Free 120 Colum. L. Rev. No. 1 (2020). But, like QBI, it is here to stay. QBI involves a lot more revenue and will need to be extended, so there is faint hope for its demise or being cut back. I would not hold my breath, though.

Conservation Easements

Landowners are allowed a charitable contribution deduction in return for granting a conservation easement to a government or nonprofit org. Conservation easements restrict future developments (in theory forever) to preserve open space and protect the environment. But the mechanism is subject to serious abuse, at least as some apply it. The IRS has been battling syndicators who buy land to resell it to tax shelter investors, often representing that they will get tax benefits equal to their “investments”! That is done with magic appraisals – somehow conveying land to a PTE and imposing a conservation easement result in the easement itself being worth 4X what the promoter paid for the land, just days previously. I have blogged about it here.

This is something that Congress should rein in, rather than just leaving the IRS to fight abuse on a case-by-case basis. (The IRS has made these listed transactions – i.e., presumptively subject to higher penalties etc.) In the larger scheme of things there isn’t a massive amount of revenue involved, but the law should be fixed as a matter of equity and to maintain respect for the tax system. A bill, Charitable Contribution Integrity Act of 2021, has been introduced to address these problems with the backing of the Land Trust Alliance, a nonprofit that represents many land trusts that receive the easements. The bill limits the appraisal magic to 2.5X (radical, eh?) and is estimated to raise $12 billion over 10 years (chump change for the feds, of course). Using it to fund BBB seems like a no-brainer. It has bipartisan support (Senators Grassley and Daines, for example).

There had been talk about including it in BBB, but it did not get put into the House version of BBB. Guess who was standing in the way of that:

The proposed law cleared the House Ways and Means Committee this year but didn’t make it into the House version of Biden’s $1.75 trillion spending bill. The obstacle was Senator Kyrsten Sinema, an Arizona Democrat. Her opposition has led to tense negotiations in an evenly divided Senate. Sinema’s office didn’t reply to requests for comment.

Bloomberg

Similar coverage by Huffpost and Daily Beast. Even though Senator Wyden, the chair of Senate Finance, backs the legislation, I assume its chances in a final BBB deal are not great because of Sinema’s opposition. I hold out some hope that the “smartest person in the room” might figure out that this is one instance where good policy also makes good politics. This quote from a Sinema staffer in the Daily Beast story gives me some hope:

John LaBombard, a spokesperson for Sinema, told The Daily Beast that the senator has heard from Arizona officials and constituent groups—specifically citing hospitals and colleges—who have concerns with “the approach under consideration for this legislation.”

Sinema “shares the goal of stopping abusive comprehensive easement practices and believes that comprehensive reforms are needed,” LaBombard said, but added that she “believes that such reforms must be designed thoughtfully, after a robust review process that includes the views of impacted stakeholders—because oversimplified legislation could have a chilling effect on legitimate charitable donations of lands for conservation, hurting states like Arizona.”

“The senator looks forward to continuing discussions with the bipartisan group of senators examining this challenge,” LaBombard said.

Daily Beast, 12/15/21

The charitable groups that are talking to her must think that the 2.5X limit may be generalized to more gifts of property outside of the conservation easement context? That is a version of the age-old slippery slope argument. (Of course, I think policy should sled down that slope with no worries. Taxpayers should only be given a charitable deduction for their tax basis when they contribute appreciated property. But I’m not part of the charitable-industrial complex that seems to justify virtually anything to encourage charitable contributions.) The bill has a 3-year window on the limit (i.e., property held longer than three years would not be limited to 2.5X of basis). So, the groups must be concerned about rapidly appreciating properties. Ugh.

This is a small-bore issue; it has some Republican support; and support from environmental groups should inoculate against bogus environmental attacks. But my grasp of retail politics is weak. Sinema’s opposition illustrates why it is so difficult to reform tax expenditures.

Close margins can distort policy

None of this is surprising. It happens in legislative bodies when thin majority make it difficult to put together majority support for budget bills. That can give immense power to a few legislators who are reluctant to support a proposal and use that as leverage to extract idiosyncratic or special concessions. It is a variant on adding earmarks for local projects to get votes. In Minnesota, the practice comes up frequently in bonding bills that require supermajority approval and are largely collections of individual projects.

I personally saw it with tax bills a few times – most vividly in the early 1980s when then Governor Quie added two quirky tax expenditures to get the votes of two Republican House members for a tax increase under an agreement with the DFL legislature. The DFL had a very thin House majority and several members who refused to support a tax increase, requiring a couple GOP votes. The two provisions had a short shelf life; they were repealed a session or two later. That seems less likely with the provisions Sinema is insisting on. For conservation easements, it will drain resources from the IRS and the courts, as those syndicated deals are likely to be disallowed by the IRS and fail in court. However, some may simply go undetected.

It is difficult for me judge whether this effect is qualitatively different or worse for tax provisions. as compared with spending projects and earmarks. It seems worse to me, because it distorts the tax system affecting many taxpayers, as opposed to simply spending money on a few projects and increasing the federal debt. But that may be because I think too much about taxes and the tax structure. Tax expenditures (e.g., QBI and conservation easements) could be cast as little different than appropriation earmarks or bonding projects.

It certainly makes it clear that empowering moderates (Sinema, anyway) does not necessarily lead to better policy if one’s benchmark follows textbook principles, such as promoting horizontal equity and simplicity. Her preservation of QBI and syndicated conservation easements and insisting on a book income AMT rather than a simple corporate rate increase all move in the wrong direction.

Update 3/23/2023

Since this was written and initially posted much has happened. Sinema has become an independent and a lefty Democrat is running for her Senate seat. Whether she is running for reelection or can win, as an independent or Republican candidate, is unclear. The consensus she cannot win a Democratic primary.

This recent Politico article by Jonathan Martin is interesting account of her moving away from the Democratic caucus and potentially into becoming a Republican. All this is the usual political maneuvering. Mitch McConnell does not sound interested, but Mitt Romney, who Martin interviewed and who has worked with Sinema, thinks he should be. Romney conveyed this scary thought, which is why I decided to add an update to this ancient post for archival purposes:

At least one prominent Senate Republican is hoping McConnell attempts a negotiated peace with Sinema.

“If he hasn’t he should,” Sen. Mitt Romney (R-Utah), who has worked closely with Sinema, told me. Romney jokingly said that McConnell should even offer her the gavel of the influential Senate Finance Committee to sweeten the deal.

Jonathan Martin, Sinema Trashes Dems: ‘Old Dudes Eating Jell-O’

There is zero chance she’ll end up as chair of Finance, at least in most universes I know, but it’s still a scary thought. That she refused to sign on to tepid limits on syndicated conservation easements says it all. This quote from the article is yet more evidence of that and why she defended QBI:

It’s hard to overstate Sinema’s closeness with private equity, in particular. She spent part of her 2020 summer recess interning [what?!] at a Sonoma winery owned by an executive in the industry; she single-handedly ensured taxing carried interest on private equity earnings was kept out of the IRA legislation, as Schumer memorably blurted out. And one senior administration official told me they’ve concluded the way to win Sinema’s vote on a crucial agency nominee is to have private equity executives weigh in with her.

Jonathan Martin, Sinema Trashes Dems: ‘Old Dudes Eating Jell-O’

As is obvious from its title, Martin’s article is colorful (including her take on toppings elderly male senators like on Jell-o varying by region – I assume this is all a bad joke invented for the fundraising circuit) with lots of details (e.g., Sinema’s expensive tastes for private jets and luxury hotels).

The country desperately needs more centrists in Congress, so I’m conflicted as to whether to hope she somehow figures out a way to get reelected, whether as an independent or a Republican. I guess I would opt for a centrist in the pocket of various interest groups as opposed to an extreme partisan like Kari Lake or Rueben Gallegos. Proverbial choice between a rock and hard place.

Categories
income tax

Charitable contributions and naming rights

Malcolm Gladwell’s proposes (A Modest Proposal For the Future of Public Philanthropy) donors be required to choose between taking a tax deduction or public recognition for their contribution (having a building named after themselves in Gladwell’s example). This was his reaction to Empire of Pain, the best seller about the Sackler family, the pill pushing philanthropists who were instrumental in causing the opioid epidemic. Anyone who frequents museums, especially in NYC, knows how many galleries and buildings are named after them.

Gladwell’s rhetorically riffs of Jesus’s moral exhortation in Matthew 6 to give for the right reasons, not public recognition. Insisting on slapping your name on a building is the antithesis of that. As always, Gladwell is entertaining and the piece worth reading.

My reactions
  • Not a bad idea but I would be happy to allow naming rights for cash contributions. That would give us a double dipping scorecard. If your name appears on the building, scholarship, PBS program or similar, we then know you only deducted income that otherwise would have been taxed. Deduction of untaxed appreciation did not shelter your other income from taxation. That would apply to nearly as many buildings as Gladwell’s, I’d guess.
  • Reading Matthew 6 reveals a more fundamental problem with these “charitable” contributions. Jesus was addressing helping the needy, classic charity. The giving Gladwell describes and a vast amount that qualifies for the tax deduction fails to clear that bar. How much does another Harvard building help the poor? Less than the present value of the tax benefits from the contributions in nearly all cases.
Categories
income tax

Half of households give to charity

according to a biennial study by the Lilly Family School of Philanthropy:

The percentage of American households that donate to charity fell to 49.6 percent in 2018 for the first time since the Philanthropy Panel Study begin tracking charitable giving.

THE GIVING ENVIRONMENT: Understanding Pre-Pandemic Trends in Charitable Giving p. 7 (July 2021). (pdf)

That is a 16 percentage point decline since 2000. Other data sources (CES, CPS, etc.) show a similar but less pronounced trend. The study, which is worth skimming for those interested in charitable giving, goes through various rationales for the decline, which began markedly during the Great Recession but has continued to increase in its aftermath. Possible explanations include changes in income and wealth, declines in religious affiliation and attendance (declines were larger for religious charities than secular), and more.

The declines in participation have been offset by increases in dollars given – mainly by high income households. The economy has been good over the last decades to those in the top income and wealth strata with the inexorable march of inequality. The authors’ regression analysis finds about one-third of the decline is attributable to changes in income and wealth.

2018, of course, is the first year that TCJA’s changes to the charitable deduction rules were effective. Its changes, as I have discussed before, eliminated the federal income tax benefits of giving for most families who give average amounts and who don’t pay substantial mortgage interest. TCJA’s dramatic increase in the standard deduction and capping of the SALT deduction accomplished that feat. The study makes no reference to the effects of tax incentives, much less TCJA’s changes.

I personally doubt that effect of TCJA’s changes would show up in 2018 for most households. It takes a while for information on changes in tax effects to filter down and, then, for people to respond by adjusting their behavior. (One meaningless data point: I gave a seminar at my church on giving options to respond to TCJA’s new rules in fall 2018. Conversations in later months made it clear to me that most people act in response to advice by their tax preparers or after doing their taxes – i.e., often in the following year. Media stories, presentations, and similar likely have little effect. The people I was interacting with are dedicated, regular givers. Casual givers probably are even slower to respond.) I will be interested to see what the next edition of the Lilly survey finds. TCJA’s changes certainly would seem likely to reinforce trends that have been occurring for other reasons.

The trend – reduced general participation in giving and more giving by higher income folks – makes a presumptive case for redesigning federal and state tax incentives or supplementing existing incentives so they work better for average taxpayers. (I favor redesign, not adding more just to be clear. The nonprofit community will not agree.)

The current structure is skewed to and primarily used by high-income folks and big givers. The trend to less giving by average folks is concerning – especially for those who think a healthy charitable sector is important and who think that the interests and concerns of big givers diverge from those of ordinary folks. The current systems works exceedingly well to encourage gifts of appreciated property for Ivy League buildings, art museums, medical facilities, and similar. Not as well to stimulate small dollar donations to local food shelves and homeless shelters.

That means moving away from the itemized deduction to a credit or layering on a credit in addition to the deduction. I have expressed my thoughts before on how Minnesota should do that, so I won’t repeat myself.

A Chronicle of Philanthropy story (Haleluya Hadero, Share of Households Donating to Charity Drops to Lowest Level in Nearly 20 Years, July 27, 2021) on the Lilly Family School of Philanthropy study includes some reactions from the authors and others.

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