Tag: charities

In a previous post I outlined why Minnesota’s tax incentives for charitable contributions should be reformed. This post outlines how I would do that and why I think the basic features I’m suggesting make sense.  Obviously, others with different values or goals may disagree and opt to substitute or replace some or all of those features.

The goals or principles that I looked to for my reform. Before describing its features, it is useful to describe how I decided on or evaluated alternatives for a new Minnesota charitable tax incentive.  I was motivated by three basic goals or principles:

• Increase giving.  A principal goal of any charitable contribution incentive is to encourage more giving than would otherwise occur.  That was my primary goal as well.  There is empirical evidence that tax incentives do that.  See, e.g., Jon Bakija and Bradley T. Heim, How Does Charitable Giving Respond to Incentives and Income? New Estimates from Panel Data, National Tax Journal, vol. 64 (2, Part 2) (June 2011), pp. 615–650 (summarizing the literature as well as estimating elasticities in excess of -1). Larger percentage reductions generally have bigger effects – in other words, a 20% reduction in the cost of giving should yield more contributions than a 10% or 5% reduction.  This provides general support for Minnesota providing tax incentives, if one accepts (as I do) the merit of encouraging more charitable contributions.
• Political considerations, including fairness. Increasing giving can’t be the only goal of an incentive, though.  For example, if empirical evidence suggested that it was most cost effective (i.e., increased dollars of contributions/forgone tax revenue) to target an incentive only to millionaires, we still would not do that because it is inconsistent with our egalitarian values and because implicitly the government/tax money will go to the charities that millionaires prefer.  As critics of the current federal structure have argued, limiting the incentives to a narrow group (9% of filers with the highest incomes) is probably not sustainable politically.  Thus, an incentive should be widely available (“fair” to the average person) and benefit most charities.  Bakija and Heim (see above) fortunately did “not find strong evidence of differences in persistent price elasticities across income levels.” (p. 647) That makes the case easier for using state tax policy to balance out the imbalance in TCJA’s skewing of who gets federal incentives.
• Simplicity, understandability, and ease of tax administration and enforcement. All these goals work together.  Provisions that are simpler and easier to understand for the public (taxpayers) are also easier for tax administrators to explain and enforce.  These factors become more important design features when a state deviates from the federal rules, because the state can no longer rely on the IRS to enforce or national publicity to get the word out on how the provision works.

There are four key features of my proposed fix:

1. Use a credit rather than a deduction.
2. Allow the credit only to those without access to the federal tax incentives.
3. Limit the credit to cash contributions only.
4. Require a minimum threshold of contributions before the credit applies.

#1: Use a credit rather than a deduction.  I would repeal both of Minnesota’s current incentives – the itemized deduction and subtraction for non-itemizers – and replace them with a credit.  Several reasons favor using a credit instead of a deduction.  A credit provides the same percentage incentive (i.e., the credit rate) to all givers.  This is unlike a deduction, which provides a larger tax benefit or incentive, based on what tax bracket the donor is in.  Donors with more income and, thus, in higher tax brackets get higher percentage tax benefits.  That might not be bad if higher income donors respond more robustly to incentives and there is some evidence for that, but to me it is outweighed by the value of treating all donors alike.  A credit allows the flexibility of setting a credit that provides a more powerful incentive than a deduction would.  A deduction’s benefit is determined by the tax rate schedule.  But for a credit we can set the rate at any level (e.g., 15% or 20%).  That allows the flexibility to make a targeted incentive two or three times higher than a deduction, where the typical tax benefit is less 8% of the contribution.  My guess is that on a revenue neutral basis, my proposal would have about a 15% credit rate.

#2: Allow the credit only to those without access to federal tax incentives. I would restrict those who qualify for the new credit to taxpayers who neither itemize deductions for federal purposes nor who make direct transfers from an IRA to charities, the two basic ways to receive federal tax benefits.  I would fence out these individuals for three reasons:

1. These individuals already qualify for a substantial federal tax incentive (typical federal tax benefit for an itemizer is 22% or more of the contribution) and so are less in need of encouragement from the state.  Those who make IRA transfers to charity already qualify for a Minnesota tax benefit in doing so and we should encourage them to make most of their charitable contributions in that way.  Denying them the credit would do that.
2. Focusing the proposed credit on those who do not receive federal tax benefits will allow a much higher credit rate (i.e., a bigger incentive) for the same revenue cost – a reasonable guess is the proposed credit can have a rate of 15% or more, but that would drop by half or more if contributors who get federal tax benefits are included.
3. It will help right some of the wrongs that Congress did to federal charitable giving incentives in enacting the TCJA.

#3: Limit the credit to cash contributions. To qualify for the credit all the basic federal rules for the itemized deduction for charitable contributions would apply (e.g., the IRS documentation requirements), except that contributions would be required to be made in cash.  (I’m open to cutting out contributions to private foundations and/or donor advised funds.  But don’t think either limitation would matter a great deal because most of those contributions will qualify for federal tax incentives and be fenced out under my fix.) There are multiple rationales for focusing the credit on cash only. The main ones are:

1. Cash is the life blood of most charities.  Some contributions of property cannot be easily turned into cash (publicly traded securities are the exception).  Even if they are directly used in the charity’s mission, such as art donated to a museum, they have much lower utility to the charities than a cash donation which can be used for its highest priorities.  Given that reality, the state should not use its scarce resources to incent gifts of property other than cash.
2. Allowing incentives pegged to the fair market value of appreciated property violates basic tax policy principles by allowing a tax benefit for donating a capital gain that has not been included in income.  (Explanation: This would be like allowing someone making an IRA transfer to a charity (which is excluded from income) also to deduct it, reducing the tax on other income. No one would suggest doing that; the deduction of appreciation is a historical quirk that long ago should have been eliminated by Congress.) The benefits mainly flow to the affluent.  If the gift is of publicly traded securities, the giver can just as easily sell them as the charity and give the cash if he or she wishes to qualify for the credit.
3. Property contributions create nettlesome compliance and administration problems for the IRS and the Department of Revenue (DOR).  The main ones relate to valuing the property for other than publicly traded securities.  For example, a cursory reading of federal tax court cases shows that the IRS is fighting a losing battle with people who overvalue gifts of used clothing even though the statute and regulations have tightened the documentation requirements substantially.  Since the credit will not apply to contributions deductible under the federal tax (thus, the IRS won’t care), I don’t want to put added burdens on DOR.
4. Large contributions (e.g., contributing art or real estate) will qualify for federal tax benefits and, thus, won’t be at issue under the credit in any case.
5. The many practical and policy problems created by federal law’s allowance of the deduction of the fair market value of property have been documented and described in detail by Professor Roger Colinvaux.  The extensive ongoing litigation and IRS administrative efforts related to donations of syndicated conservation easements, much of which relate to valuation games being played by developers and the complicit charities that work with them provide a recent, high-profile example.  See Peter Reilly’s blog posts here and here.  The IRS has gone so far as to designate some syndicated conservation easements as listed transactions.

#4: Require a minimum threshold or floor of contributions before the credit applies. I would set a minimum level of contributions that must be made each year before the new credit would apply.  I would set this at 2% of adjusted gross income or $1,000, whichever is greater.  A threshold restriction like this has frequently been suggested by tax policy experts as a way to focus the incentive where it matters – that is, at the margin by not extending the credit to the smaller contributions that many givers would make with or without an incentive.  It allows setting the revenue neutral credit rate higher to enhance the incentive where it matters most.  A threshold also helps improve compliance, since contributors will be less tempted to claim small amounts on the theory it won’t be practical to audit them.  There is no magic to the two numbers that I picked.  They are higher than $500 threshold under the current Minnesota non-itemizer subtraction.  That will allow a higher credit rate (stronger or more powerful incentive) at the same revenue loss.  I think it is important to include a percentage threshold or floor, so the limit rises as income rises.  The non-itemizer subtraction does not do that, likely because when it was enacted most donors with higher incomes would be itemizers.

Other more minor elements.  I would set the maximum donation that qualifies for the credit equal to the basic standard deduction amount. This is a corollary of not allowing the credit to those who qualify for the federal itemized deduction. Setting the maximum at that level will prevent most taxpayers from forgoing the federal itemized deduction to claim the Minnesota credit if doing so would generate more total tax savings.  One needs to always recognize that tax advisors will figure out how to maximize combined federal and state savings and file returns accordingly, even if their clients (the donors) are unaware of it and thus are not modifying their giving behavior in response.  In any case, I want to discourage donors from forgoing some federal savings to realize bigger state savings. The underlying goal is to have the federal treasury bear the cost whenever possible.

Overall, I think my proposed fix would help right some of the wrongs done by TCJA’s changes and would help increase charitable giving in Minnesota. For a state with its sterling reputation for charitable efforts, Minnesota should have a state-of-the-art tax incentive for giving. I think the parameters of my proposed reform would be a big step in that direction. I’m sure they could be refined and improved, but the discussion should start now that the 2019 legislature adopted the main TCJA provisions affecting charitable giving.